Austrian Economist, Joseph Schumpeter, popularized the concept of “creative destruction” in his 1942 book, Capitalism, Socialism, and Democracy. The principle behind creative destruction is that sustained economic development depends on innovative entrepreneurs destroying the value of established (and sometimes monopolistic) companies through the introduction of new products and ideas. Because the established companies create significant barriers to entry in the market, these entrepreneurs are forced to adopt radically different approaches. If their radical products or ideas prove more useful, they will take down the established giant, and create a fundamental improvement. This threat is so real that it forces established companies to stay one step ahead of innovators, and adopt new products or ideas on their own, which also creates a fundamental improvement.
Creative destruction is an expression of the efficiency of free markets, and is openly regarded as an important feature of the American economy.
So how do we explain the global financial crisis of today? Creative self-destruction.
While creative destruction relies on the continuous cycle of improvement, creative self-destruction is something different, but related. The problem with creative self-destruction is that short term gains are supplanted by bitter long term losses coupled with additional governmental restrictions.
How does this creativity that we depend on become self-destructive? Within the post-Cold War globalization framework, companies explored newer, and broader opportunities. These opportunities were principally driven by relaxed government involvement, and the American consumer who made up 70% of the our economic engine. The process of normal creative destruction was halted as established companies consumed every innovative measure. These companies, through a series of corporate mergers, became ultra-vital to the economic structure and thus “too big to fail.” Combining fewer economic players with poor balance sheets and a government that encouraged unhealthy growth proved to be too much for the system to sustain itself. The globalized system was too reliant on the American consumer and once the negative pressures of over-securitized mortgages, and sub-prime lending overtook the American appetite for consumption, everything came crashing down. Thus, creative self-destruction.
Note: We will revisit this topic later, and go into more detail as to how to reestablish a creative destruction framework without excessive governmental involvement that impinges upon vibrant entrepreneurial growth.