Creation and destruction

This is the time of the “Year in Review” articles. This year it is the “Decade in Review” as we move into the “teens”. This one, at the Wall Street Journal, caught my eye — Creativity, Meet Destruction:

To understand the challenges that faced businesses the past 10 years, consider the household names that didn’t make it through the decade: Anheuser-Busch, Compaq, Gillette, Enron, Lehman Brothers, Merrill Lynch, WorldCom.
. . .
“This is what [Austrian economist Joseph] Schumpeter had in mind with his term ‘creative destruction,'” says Paul David, an economic historian at Stanford University. Industrial collapse is a “messy, messy process,” Mr. David says. “It’s a great drama, and watching it play out in this decade has been very interesting.”

Much has been said about Schumpeter’s phrase “creative destruction.” The phrase is a way to capture the dynamic action of the economy where the new replaces the old. The Journal pieces cites the internet as a classic example of a new technology creating a new business model that replaces the old way of doing things. We also call this “innovation.”

Too often, however, “creative destruction” it has been used to justify non-creative processes. The argument here is that we have to allow economic forces to crush certain activities in order for new activity to flourish. Thus, under this view, high unemployment and high bankruptcy rates are good because it frees up resources.

This view has the process backwards. Destruction does not necessarily cause creation. Creative activities – innovation – draw resources from the old to the new. Yes, you may have to tear down the old house to build the new. But tearing down the old house doesn’t necessarily mean the bricks will magically reform themselves into a new building. Nor will economic forces immediately flow into the vacuum: the vacant lot may side empty for decades.

And remember that not all destruction is part of “creative destruction” process. Take for example the companies listed in the beginning of the Journal article. Anheuser-Busch was part of a corporate take-over. No “creation” there – and the “destruction” will probably be “corporate rationalization.” Lehman Brothers and Merrill Lynch didn’t fall to a new business model or economic change. Nor was Enron’s fall due to some one taking their business away because of a better way of doing things. And last I checked, Gillette razor’s were still available – even if the company is not an independent entity.

So, let’s not confuse corporate restructuring with innovation. When someone explains why the closing of a company or a takeover of one firm by another that simply reduces competition is all part of the great goal of “creative destruction”, ask them where the creative part is.

And let’s focus our public policy on the innovation side of the equation. We need to ensure that access to resources doesn’t become a barrier to innovation and the creative part of the process. But that doesn’t mean destruction for destruction’s sake.

[Note: in fairness to the author of the Journal article, the piece really is about the changes in the decade. It is just that the opening examples don’t fit the rest of the story.]

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