What is the defining characteristic of capitalism? Some say profit. Others, private ownership. Still others, rapacity. Considering that capitalism may have begun as early as the 16th century, in England, it took a long time for us to come up with the most impressive answer, at least to date: creative destruction.
It’s a term you’ve heard and likely experienced firsthand—if you switched from compact discs to Spotify, if you’ve ordered something from Amazon, if you’re invested in cryptocurrency, or if you remember the morning paper in the driveway. Creative destruction, according to Chicago Booth Review, is “when innovation brings about the decline or demise of established products or enterprises.”
More poetically, it’s “the fundamental impulse that gets and keeps the capitalist engine in motion … the essential fact of capitalism.” That’s a direct quotation from the economist who popularized the term “creative destruction”—Joseph Schumpeter—in his 1942 book, Capitalism, Socialism and Democracy.
Twenty-first century examples of creative destruction abound, but the most obvious destructive force looming over us is artificial intelligence. OpenAI’s ChatGPT and similar chatbots are seemingly poised to take our jobs, and the adoption of other forms of AI will almost certainly cause profound economic shifts. As The Economist observed more than two years ago, these innovations “could not describe creative destruction with more Schumpeterian eloquence.” Schumpeter’s concept of creative destruction would dictate that as businesses adapt to the disruption, a more robust economy will result.
A brief history of creative destruction.
Born in 1883, Schumpeter studied law in Vienna, served briefly as Austria’s finance minister, and later taught economics at Columbia and Harvard universities. In writing Capitalism, Socialism and Democracy, Schumpeter sought to disrupt the orthodox view of “the static, steady-state equilibrium thinking” of the reigning neoclassical school, writes Thomas M. Humphrey, a former senior economist at the Richmond Fed, and replace it with “a dynamic … theory of cyclical growth.” Schumpeter wanted a theory that could better explain “the dynamism of capitalist economies” that reflected the “real-world business behavior” he observed.
To Schumpeter, capitalism was a long-term progression of growth, built from shorter growth cycles linked together. This built on his work on economic cycles, with the entrepreneur as the all-important spark. All humans create, Schumpeter believed, but he was the first (in 1911) to identify the entrepreneur as a very specific kind of creator who drives creative destruction in capitalist economies.
According to Schumpeter’s growth cycle, the entrepreneur innovates (with the help of outside financing), achieves increased profit margins (prosperity) that cause imitators to rush in and drive up supply until demand wanes, causing prices to fall (recession) until the inefficient competitors leave and the economy “absorbs the innovators and consolidates the … gains.”
The “mother of all creative destruction,” Britain’s Industrial Revolution, marked the beginning of the end of Western mercantilist society and the birth of modern capitalist economies. The wealth and new jobs created in such new centers of wealth as Manchester and Glasgow also led to Dickensian poverty, Luddite wars, and the destruction of the wool industry, which had been for centuries the center of Britain’s textile industry.
Instability as a feature, not a bug.
It’s a messy, unstable process to be sure, but a highly productive one, producing an unprecedented era of prosperity in the largely capitalist West beginning in about 1820. “Real per-capita income of the West increased nearly threefold between 1000 and 1820 and twentyfold from 1820 to 2001,” according to the American Enterprise Institute.
Edward Jones, a senior lecturer in economics at Bangor University’s business school, said Schumpeter took a conclusion by Karl Marx (he had studied Marx closely and thought he had gotten much right) and turned it on its head. Marx thought capitalism was unstable, which is why it would not last. Schumpeter said yes, capitalism is unstable—which is why it works. The vital instability of creative destruction is at the heart of capitalism, Schumpeter believed, and any conception of capitalism that didn’t include it was just a lifeless imitation—“like Hamlet without the Danish prince.”
Schumpeter was confident that his theory addressed criticisms of capitalism, most of which he believed failed to view reality correctly—which is to say, over the long term. For example, monopolies seemed powerful only when considered in the short run. Over longer periods, monopolies were just as threatened by “the perpetual gale,” as he called it, of change brought on by creative destruction as any business.
In fact, Schumpeter contended that “creative destruction is powerful both as a fact and a threat,” meaning that it’s so keenly felt by all economic participants that the force of creative destruction works even as a threat, motivating companies to innovate before a competitor gets there first. As Walter Isaacson relates in his biography of Apple founder Steve Jobs, the firm’s business office hated Jobs’ decision to sacrifice the highly profitable iPod for the new iPhone. Jobs told Isaacson that if he hadn’t been willing to kill the iPod, “a start-up would combine both features in one product and leave Apple in the dust. To survive, Apple had to destroy its best-selling gadget.”
As for accusations that capitalism creates unfair wealth disparities, Schumpeter believed capitalism delivered “faster growth and higher living standards, especially of the middle- and lower-income classes, than any other economic system, albeit in a disruptive, jerky fashion.”
The role of human creativity.
Schumpeter thought that creative destruction contained the seed of capitalism’s eventual demise. Like Marx, Schumpeter believed capitalism would ultimately collapse, not by failing but by succeeding, largely because of creative destruction. Capitalism’s successes would produce “social forces—the routinization and depersonalization of innovation, the destruction of the image of the entrepreneur as romantic hero, the creation of a class of intellectuals hostile to capitalism,” says Humphrey—all of which would corrode the capitalist system from within. Capitalism would succeed economically but fail sociologically.
If creativity is a defining characteristic of humans, then perhaps there’s something inevitable about capitalism, a constant urge toward creative destruction. In Schumpeter’s view, says Jones, human creativity is an unlimited resource. We can’t stop breakthroughs even if we wanted to. Humans have an ever-present desire to change things, to improve them, to discover and devise new methods and resources. Perhaps Schumpeter was right on the economics, but wrong on the sociology.
In his lifetime, Schumpeter never received the academic acclaim he may have thought he deserved. His contemporary, John Maynard Keynes, eclipsed Schumpeter with his diagnosis of the causes behind the Great Depression, ideas that quickly gained acceptance. Not given to self-promotion, and as a more historical economist outside the quantitative mainstream that took hold beginning of the 1930s, Schumpeter remained uninfluential within the academy, even as his reputation grew toward the end of the last century on the street, in the business community, and among journalists. By then, empirical proof of his ideas of creative destruction, which had been weak, began to emerge.
The 1990s saw three biographies of Schumpeter, with the definitive biography—Thomas McCraw’s Prophet of Innovations: Joseph Schumpeter and Creative Destruction (2007)—a reappraisal of Schumpeter that economist Tyler Cowen called “as good a biography of an economist as has ever been written.” Two years later, The Economist began a regular column on innovation. Its name? “Schumpeter.”
