By Richard Alm and W. Michael Cox
Joseph Schumpeter (1883–1950) coined the seemingly paradoxical term “creative destruction,” and generations of economists have adopted it as a shorthand description of the free market’s messy way of delivering progress. In Capitalism, Socialism, and Democracy (1942), the Austrian economist wrote:
The opening up of new markets, foreign or domestic, and the organizational development from the craft shop to such concerns as U.S. Steel illustrate the same process of industrial mutation—if I may use that biological term—that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. (p. 83)
Although Schumpeter devoted a mere six-page chapter to “The Process of Creative Destruction,” in which he described capitalism as “the perennial gale of creative destruction,” it has become the centerpiece for modern thinking on how economies evolve.
Schumpeter and the economists who adopt his succinct summary of the free market’s ceaseless churning echo capitalism’s critics in acknowledging that lost jobs, ruined companies, and vanishing industries are inherent parts of the growth system. The saving grace comes from recognizing the good that comes from the turmoil. Over time, societies that allow creative destruction to operate grow more productive and richer; their citizens see the benefits of new and better products, shorter work weeks, better jobs, and higher living standards.
Herein lies the paradox of progress. A society cannot reap the rewards of creative destruction without accepting that some individuals might be worse off, not just in the short term, but perhaps forever. At the same time, attempts to soften the harsher aspects of creative destruction by trying to preserve jobs or protect industries will lead to stagnation and decline, short-circuiting the march of progress. Schumpeter’s enduring term reminds us that capitalism’s pain and gain are inextricably linked. The process of creating new industries does not go forward without sweeping away the preexisting order.
Transportation provides a dramatic, ongoing example of creative destruction at work. With the arrival of steam power in the nineteenth century, railroads swept across the United States, enlarging markets, reducing shipping costs, building new industries, and providing millions of new productive jobs. The internal combustion engine paved the way for the automobile early in the next century. The rush to put America on wheels spawned new enterprises; at one point in the 1920s, the industry had swelled to more than 260 car makers. The automobile’s ripples spilled into oil, tourism, entertainment, retailing, and other industries. On the heels of the automobile, the airplane flew into our world, setting off its own burst of new businesses and jobs.
Americans benefited as horses and mules gave way to cars and airplanes, but all this creation did not come without destruction. Each new mode of transportation took a toll on existing jobs and industries. In 1900, the peak year for the occupation, the country employed 109,000 carriage and harness makers. In 1910, 238,000 Americans worked as blacksmiths. Today, those jobs are largely obsolete. After eclipsing canals and other forms of transport, railroads lost out in competition with cars, long-haul trucks, and airplanes. In 1920, 2.1 million Americans earned their paychecks working for railroads, compared with fewer than 200,000 today.
What occurred in the transportation sector has been repeated in one industry after another—in many cases, several times in the same industry. Creative destruction recognizes change as the one constant in capitalism. Sawyers, masons, and miners were among the top thirty American occupations in 1900. A century later, they no longer rank among the top thirty; they have been replaced by medical technicians, engineers, computer scientists, and others.
Technology roils job markets, as Schumpeter conveyed in coining the phrase “technological unemployment” (Table 1). E-mail, word processors, answering machines, and other modern office technology have cut the number of secretaries but raised the ranks of programmers. The birth of the Internet spawned a need for hundreds of thousands of webmasters, an occupation that did not exist as recently as 1990. LASIK surgery often lets consumers throw away their glasses, reducing visits to optometrists and opticians but increasing the need for ophthalmologists. Digital cameras translate to fewer photo clerks.
Companies show the same pattern of destruction and rebirth. Only five of today’s hundred largest public companies were among the top hundred in 1917. Half of the top hundred of 1970 had been replaced in the rankings by 2000.
“The essential point to grasp is that in dealing with capitalism we are dealing with an evolutionary process,” Schumpeter wrote (p. 82).
The Power of Productivity
and competition fuel creative destruction. Schumpeter summed it up as follows:
The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates. (p. 83)
Entrepreneurs introduce new products and technologies with an eye toward making themselves better off—the profit motive. New goods and services, new firms, and new industries compete with existing ones in the marketplace, taking customers by offering lower prices, better performance, new features, catchier styling, faster service, more convenient locations, higher status, more aggressive marketing, or more attractive packaging. In another seemingly contradictory aspect of creative destruction, the pursuit of self-interest ignites the progress that makes others better off.
Producers survive by streamlining production with newer and better tools that make workers more productive. Companies that no longer deliver what consumers want at competitive prices lose customers, and eventually wither and die. The market’s “invisible hand”—a phrase owing not to Schumpeter but to Adam Smith—shifts resources from declining sectors to more valuable uses as workers, inputs, and financial capital seek their highest returns.
Through this constant roiling of the status quo, creative destruction provides a powerful force for making societies wealthier. It does so by making scarce resources more productive. The telephone industry employed 421,000 switchboard operators in 1970, when Americans made 9.8 billion long-distance calls. With advances in switching technology over the next three decades, the telecommunications sector could reduce the number of operators to 156,000 but still ring up 106 billion calls. An average operator handled only 64 calls a day in 1970. By 2000, that figure had increased to 1,861, a staggering gain in productivity. If they had to handle today’s volume of calls with 1970s technology, the telephone companies would need more than 4.5 million operators, or 3 percent of the labor force. Without the productivity gains, a long-distance call would cost six times as much.
The telephone industry is not an isolated example of creative destruction at work. In 1900, nearly forty of every hundred Americans worked in farming to feed a country of ninety million people. A century later, it takes just two out of every hundred workers. Despite one of history’s most thorough downsizings, the country has not gone hungry. The United States enjoys agricultural plenty, producing more meat, grain, vegetables, and dairy products than ever, thanks largely to huge advances in agricultural productivity.
|New Product||Labor Needed||Old Product||Labor Released|
|Travel agents||Ship hands|
|Computer engineers||Slide rule||Millwrights|
|Electrical engineers||Filing cabinet||Clerks|
|Fax machine||Programmers||Express mail||Mail sorters|
|Telephone||Electronic engineers||Postal workers|
|Optical engineers||Overnight coach||Coach drivers|
|Polio vaccine||Chemists||Iron lung||Manufacturers|
|Internet||Programmers||Shopping malls||Retail salespersons|
|Optical goods workers||Reference books||Encyclopedia|
Resources no longer needed to feed the nation have been freed to meet other consumer demands. Over the decades, workers no longer required in agriculture moved to the cities, where they became available to produce other goods and services. They started out in foundries, meatpacking plants, and loading docks in the early days of the Industrial Age. Their grandsons and granddaughters, living in an economy refashioned by creative destruction into the Information Age, are less likely to work in those jobs. They are making computers, movies, and financial decisions and providing a modern economy’s myriad other goods and services (Table 2).
|*. Fewer than 5,000.|
|Job Destruction||Now (2002)||Then||Year|
|Carriage and harness makers||
|Switchboard (telephone) operators||119,000||421,000||1970|
|Metal & plastic working machine operators||286,000||715,000||1980|
|Job Creation||Now (2002)||Then||Year|
|Airplane pilots and mechanics||255,000||0||1900|
|Truck, bus, and taxi drivers||4,171,000||0||1900|
|Actors and directors||155,000||34,643||1970|
|Editors and reporters||280,000||150,715||1970|
|Special education teachers||374,000||1,563||1970|
|TV, stereo, and appliance salespersons||309,000||111,842||1970|
Over the past two centuries, the Western nations that embraced capitalism have achieved tremendous economic progress as new industries supplanted old ones. Even with the higher living standards, however, the constant flux of free enterprise is not always welcome. The disruption of lost jobs and shuttered businesses is immediate, while the payoff from creative destruction comes mainly in the long term. As a result, societies will always be tempted to block the process of creative destruction, implementing policies to resist economic change.
Attempts to save jobs almost always backfire. Instead of going out of business, inefficient producers hang on, at a high cost to consumers or taxpayers. The tinkering shortcircuits market signals that shift resources to emerging industries. It saps the incentives to introduce new products and production methods, leading to stagnation, layoffs, and bankruptcies. The ironic point of Schumpeter’s iconic phrase is this: societies that try to reap the gain of creative destruction without the pain find themselves enduring the pain but not the gain.