creative-destruction

What Is Creative Destruction? Creative Destruction In A Nutshell

Business / By / October 16, 2023

Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.

AspectExplanation
Concept OverviewCreative Destruction is an economic concept introduced by economist Joseph Schumpeter. It describes the dynamic process in which innovation and technological advancement lead to the destruction of existing industries, businesses, and products, while simultaneously creating new opportunities for innovation, entrepreneurship, and economic growth. It is a central feature of capitalist economies and plays a vital role in driving progress and renewal.
Key Characteristics– Creative Destruction is characterized by:
1. Technological Innovation: Advances in technology that disrupt existing industries.
2. Market Competition: New entrants challenging established firms.
3. Decline and Adaptation: The decline of outdated technologies and business models.
4. Entrepreneurship: New businesses and ideas emerging in response to changing market demands.
Dynamic ProcessCreative Destruction is an ongoing, dynamic process that continually reshapes the economic landscape. It occurs as older industries and businesses face obsolescence due to innovations and new technologies, leading to the emergence of newer, more efficient, and innovative industries.
ExamplesHistorical examples of Creative Destruction include the transition from horse-drawn carriages to automobiles, the shift from film to digital photography, and the disruption of traditional bookstores by e-commerce. More recent examples include the rise of ride-sharing services challenging traditional taxi companies and the impact of online streaming on the entertainment industry.
Impact on IndustriesCreative Destruction can lead to the decline or extinction of entire industries and businesses that fail to adapt to technological change. It can also result in industry consolidation as stronger players emerge. However, it generates economic growth by fostering innovation, productivity gains, and the creation of new markets and opportunities.
EntrepreneurshipThe process of Creative Destruction often encourages entrepreneurship. New and innovative startups frequently emerge to address changing market needs and opportunities created by technological disruption. Entrepreneurs play a crucial role in driving economic progress through their willingness to take risks and pursue novel ideas.
Labor Market EffectsWhile Creative Destruction can lead to economic growth, it can also have disruptive effects on the labor market. Jobs in declining industries may be lost, requiring workers to adapt and acquire new skills for emerging sectors. Policymakers often address these challenges through workforce development and education initiatives.
Policy ImplicationsGovernments and policymakers can influence the outcomes of Creative Destruction through various measures. These include intellectual property protection, investment in research and development, and policies to support job retraining and reskilling for displaced workers. Balancing innovation and social stability is a common policy challenge.
Innovation EcosystemAn innovation ecosystem is essential for fostering Creative Destruction. It involves a network of universities, research institutions, venture capital, and supportive policies that promote innovation, entrepreneurship, and the development of new technologies. Silicon Valley in the United States is a well-known example of a thriving innovation ecosystem.
Global PerspectiveCreative Destruction is not limited to individual countries; it occurs on a global scale. The rapid dissemination of technology and ideas across borders can lead to disruptions and opportunities worldwide. Companies and countries that embrace innovation can gain a competitive advantage in the global economy.
Sustainability ConcernsAs Creative Destruction accelerates technological change, there are concerns about its impact on sustainability. Rapid innovation can result in resource depletion, environmental degradation, and social dislocation. Achieving a balance between progress and sustainability is a critical challenge for the future.
Continuous ProcessCreative Destruction is a continuous and evolutionary process that constantly shapes the economic landscape. It requires adaptability, resilience, and a willingness to embrace change, both for businesses and individuals. It is a fundamental driver of economic progress and renewal in capitalist economies.

Understanding creative destruction

Essentially, the theory behind creative destruction argues that the market status quo must be destroyed to free up the resources and energy required to innovate. From Schumpeter’s point of view, economic development was driven by the opportunity to seek profit with many dynamic market forces constantly reshaped or replaced by innovation and competition. This assumption contradicted the static mathematical models of traditional economic philosophies, which saw the balancing of supply with demand as the end goal of market processes. 

As the name suggests, there are winners and losers during creative destruction. A society cannot reap the rewards of growth and innovation without accepting that some individuals or businesses will suffer in the short or long term. History has shown that any attempts to reduce the negative aspects of creative destruction by preserving jobs or protecting vulnerable industries simply delays the inevitable. As a result, many consider the dichotomous nature of creative destruction to be the “paradox of progress”.

Examples of creative destruction

The evolution of the transportation industry is a classic example of creative destruction at work. 

During the late 1800s and early 1900s, there were incremental improvements to horse-drawn transport which allowed it to dominate the market. When the Ford Model T was released in 1908, improvements in horse-drawn transport were quickly superseded by a more innovative form of transport which has itself undergone many improvements in the last century.

Creative destruction has also occurred in the following industries:

Photography

Where Kodak film cameras were replaced with digital cameras and to a lesser extent, smartphones. What is unfortunate about the Kodak story is that the company developed one of the first digital cameras but failed to capitalise on it.

Music

The music industry has undergone many changes in the last century. Records were replaced with tapes, CDs, DVDs, mp3s, and digital music stores. Today, digital music stores have also been superseded by streaming services such as Spotify.

Internet

Many industries have also suffered because of the internet, though the internet has perhaps created more industries than it has destroyed. Nevertheless, high-speed connections rendered VHS and DVD rental obsolete. Mobile internet also disrupted taxi drivers and mapmakers. Travel agents and other service providers have also suffered because of the sheer abundance of information available online.

Key takeaways:

  • Creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets. The term was first described by Austrian economist Joseph Schumpeter in 1942.
  • Creative destruction is sometimes called the paradox of progress because, for industries to grow, there must necessarily be losers. 
  • Creative destruction is arguably most associated with advances in personal transportation, but it has also been seen in photography, music, travel, and entertainment.

Key Highlights

  • Definition and Origin: Creative destruction was coined by economist Joseph Schumpeter in 1942. It refers to the continuous process of innovation that revolutionizes economic structures by replacing old practices with new ones.
  • Concept: The theory posits that constant innovation is required for economic development. It contradicts static economic models and emphasizes the need for dynamic change in markets.
  • Winners and Losers: Creative destruction implies winners (innovators) and losers (incumbents) in the market. The process brings growth and innovation, but it also causes some individuals or businesses to suffer, creating a “paradox of progress.”
  • Examples:
    • Transportation: The evolution from horse-drawn vehicles to automobiles, like the Ford Model T, is a classic example of creative destruction in the transportation industry.
    • Photography: Kodak film cameras were replaced by digital cameras and smartphones, leading to Kodak’s missed opportunity with digital technology.
    • Music: The music industry underwent various changes with the shift from records to digital formats like CDs, mp3s, and streaming services like Spotify.
    • Internet: The internet brought both disruption and creation, rendering VHS and DVD rental obsolete while spawning new industries and affecting sectors like taxis, travel agencies, and more.

Connected Economic Concepts

Market Economy

market-economy
The idea of a market economy first came from classical economists, including David Ricardo, Jean-Baptiste Say, and Adam Smith. All three of these economists were advocates for a free market. They argued that the “invisible hand” of market incentives and profit motives were more efficient in guiding economic decisions to prosperity than strict government planning.

Positive and Normative Economics

positive-and-normative-economics
Positive economics is concerned with describing and explaining economic phenomena; it is based on facts and empirical evidence. Normative economics, on the other hand, is concerned with making judgments about what “should be” done. It contains value judgments and recommendations about how the economy should be.

Inflation

how-does-inflation-affect-the-economy
When there is an increased price of goods and services over a long period, it is called inflation. In these times, currency shows less potential to buy products and services. Thus, general prices of goods and services increase. Consequently, decreases in the purchasing power of currency is called inflation. 

Asymmetric Information

asymmetric-information
Asymmetric information as a concept has probably existed for thousands of years, but it became mainstream in 2001 after Michael Spence, George Akerlof, and Joseph Stiglitz won the Nobel Prize in Economics for their work on information asymmetry in capital markets. Asymmetric information, otherwise known as information asymmetry, occurs when one party in a business transaction has access to more information than the other party.

Autarky

autarky
Autarky comes from the Greek words autos (self)and arkein (to suffice) and in essence, describes a general state of self-sufficiency. However, the term is most commonly used to describe the economic system of a nation that can operate without support from the economic systems of other nations. Autarky, therefore, is an economic system characterized by self-sufficiency and limited trade with international partners.

Demand-Side Economics

demand-side-economics
Demand side economics refers to a belief that economic growth and full employment are driven by the demand for products and services.

Supply-Side Economics

supply-side-economics
Supply side economics is a macroeconomic theory that posits that production or supply is the main driver of economic growth.

Creative Destruction

creative-destruction
Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.

Happiness Economics

happiness-economics
Happiness economics seeks to relate economic decisions to wider measures of individual welfare than traditional measures which focus on income and wealth. Happiness economics, therefore, is the formal study of the relationship between individual satisfaction, employment, and wealth.

Oligopsony

oligopsony
An oligopsony is a market form characterized by the presence of only a small number of buyers. These buyers have market power and can lower the price of a good or service because of a lack of competition. In other words, the seller loses its bargaining power because it is unable to find a buyer outside of the oligopsony that is willing to pay a better price.

Animal Spirits

animal-spirits
The term “animal spirits” is derived from the Latin spiritus animalis, loosely translated as “the breath that awakens the human mind”. As far back as 300 B.C., animal spirits were used to explain psychological phenomena such as hysterias and manias. Animal spirits also appeared in literature where they exemplified qualities such as exuberance, gaiety, and courage.  Thus, the term “animal spirits” is used to describe how people arrive at financial decisions during periods of economic stress or uncertainty.

State Capitalism

state-capitalism
State capitalism is an economic system where business and commercial activity is controlled by the state through state-owned enterprises. In a state capitalist environment, the government is the principal actor. It takes an active role in the formation, regulation, and subsidization of businesses to divert capital to state-appointed bureaucrats. In effect, the government uses capital to further its political ambitions or strengthen its leverage on the international stage.

Boom And Bust Cycle

boom-and-bust-cycle
The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.

Paradox of Thrift

paradox-of-thrift
The paradox of thrift was popularised by British economist John Maynard Keynes and is a central component of Keynesian economics. Proponents of Keynesian economics believe the proper response to a recession is more spending, more risk-taking, and less saving. They also believe that spending, otherwise known as consumption, drives economic growth. The paradox of thrift, therefore, is an economic theory arguing that personal savings are a net drag on the economy during a recession.

Circular Flow Model

circular-flow-model
In simplistic terms, the circular flow model describes the mutually beneficial exchange of money between the two most vital parts of an economy: households, firms and how money moves between them. The circular flow model describes money as it moves through various aspects of society in a cyclical process.

Trade Deficit

trade-deficit
Trade deficits occur when a country’s imports outweigh its exports over a specific period. Experts also refer to this as a negative balance of trade. Most of the time, trade balances are calculated based on a variety of different categories.

Market Types

market-types
A market type is a way a given group of consumers and producers interact, based on the context determined by the readiness of consumers to understand the product, the complexity of the product; how big is the existing market and how much it can potentially expand in the future.

Rational Choice Theory

rational-choice-theory
Rational choice theory states that an individual uses rational calculations to make rational choices that are most in line with their personal preferences. Rational choice theory refers to a set of guidelines that explain economic and social behavior. The theory has two underlying assumptions, which are completeness (individuals have access to a set of alternatives among they can equally choose) and transitivity.

Conflict Theory

conflict-theory
Conflict theory argues that due to competition for limited resources, society is in a perpetual state of conflict.

Peer-to-Peer Economy

peer-to-peer-economy
The peer-to-peer (P2P) economy is one where buyers and sellers interact directly without the need for an intermediary third party or other business. The peer-to-peer economy is a business model where two individuals buy and sell products and services directly. In a peer-to-peer company, the seller has the ability to create the product or offer the service themselves.

Knowledge-Economy

knowledge-economy
The term “knowledge economy” was first coined in the 1960s by Peter Drucker. The management consultant used the term to describe a shift from traditional economies, where there was a reliance on unskilled labor and primary production, to economies reliant on service industries and jobs requiring more thinking and data analysis. The knowledge economy is a system of consumption and production based on knowledge-intensive activities that contribute to scientific and technical innovation.

Command Economy

command-economy
In a command economy, the government controls the economy through various commands, laws, and national goals which are used to coordinate complex social and economic systems. In other words, a social or political hierarchy determines what is produced, how it is produced, and how it is distributed. Therefore, the command economy is one in which the government controls all major aspects of the economy and economic production.

Labor Unions

labor-unions
How do you protect your rights as a worker? Who is there to help defend you against unfair and unjust work conditions? Both of these questions have an answer, and it’s a solution that many are familiar with. The answer is a labor union. From construction to teaching, there are labor unions out there for just about any field of work.

Bottom of The Pyramid

bottom-of-the-pyramid
The bottom of the pyramid is a term describing the largest and poorest global socio-economic group. Franklin D. Roosevelt first used the bottom of the pyramid (BOP) in a 1932 public address during the Great Depression. Roosevelt noted that – when talking about the ‘forgotten man:’ “these unhappy times call for the building of plans that rest upon the forgotten, the unorganized but the indispensable units of economic power.. that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyramid.”

Glocalization

glocalization
Glocalization is a portmanteau of the words “globalization” and “localization.” It is a concept that describes a globally developed and distributed product or service that is also adjusted to be suitable for sale in the local market. With the rise of the digital economy, brands now can go global by building a local footprint.

Market Fragmentation

market-fragmentation
Market fragmentation is most commonly seen in growing markets, which fragment and break away from the parent market to become self-sustaining markets with different products and services. Market fragmentation is a concept suggesting that all markets are diverse and fragment into distinct customer groups over time.

L-Shaped Recovery

l-shaped-recovery
The L-shaped recovery refers to an economy that declines steeply and then flatlines with weak or no growth. On a graph plotting GDP against time, this precipitous fall combined with a long period of stagnation looks like the letter “L”. The L-shaped recovery is sometimes called an L-shaped recession because the economy does not return to trend line growth.  The L-shaped recovery, therefore, is a recession shape used by economists to describe different types of recessions and their subsequent recoveries. In an L-shaped recovery, the economy is characterized by a severe recession with high unemployment and near-zero economic growth.

Comparative Advantage

comparative-advantage
Comparative advantage was first described by political economist David Ricardo in his book Principles of Political Economy and Taxation. Ricardo used his theory to argue against Great Britain’s protectionist laws which restricted the import of wheat from 1815 to 1846.  Comparative advantage occurs when a country can produce a good or service for a lower opportunity cost than another country.

Easterlin Paradox

easterlin-paradox
The Easterlin paradox was first described by then professor of economics at the University of Pennsylvania Richard Easterlin. In the 1970s, Easterlin found that despite the American economy experiencing growth over the previous few decades, the average level of happiness seen in American citizens remained the same. He called this the Easterlin paradox, where income and happiness correlate with each other until a certain point is reached after at least ten years or so. After this point, income and happiness levels are not significantly related. The Easterlin paradox states that happiness is positively correlated with income, but only to a certain extent.

Economies of Scale

economies-of-scale
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

diseconomies-of-scale
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Economies of Scope

economies-of-scope
An economy of scope means that the production of one good reduces the cost of producing some other related good. This means the unit cost to produce a product will decline as the variety of manufactured products increases. Importantly, the manufactured products must be related in some way.

Price Sensitivity

price-sensitivity
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.

Network Effects

negative-network-effects
In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

Negative Network Effects

negative-network-effects
In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

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Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
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