Business, Legal & Accounting Glossary
Creative destruction is the theory that suggests economies are strengthened by new companies that destroy or diminish existing companies.
Creative destruction was a term coined by Joseph Schumpeter to describe how capitalism works. According to theory for capitalistic societies to advance new companies with new infrastructure, products or services must arise and displace or destroy existing companies. This is a continually ongoing process of reinvention. According to the model the usual victims are monopolies where the lack of competition due to their extremely competitive advantage has diminished their innovation. E.g. Auto manufactures and the rise of automobiles destroyed many railroad companies. Creative destruction is a normal and healthy aspect of a capitalistic economy and according to the theory should not be hindered from progressing. If creative destruction is not allowed to occur the economy becomes bloated and inefficient.
Creative destruction can often be politically unpopular as many workers can get displaced and have their skillsets be useless for finding new jobs. Economic downturns can accelerate the process by bringing weaker firms to their demise opening new opportunities. Many of the world’s strongest firms are born in touch economic times.
The term is often coupled with phrases and buzz words such as new paradigm by many aspiring companies and start-ups who hope to change how business is done.
Renowned economist Joseph Schumpeter coined a term ‘creative destruction’ in his work titled ‘Capitalism, Socialism and Democracy’ published in 1942. It essentially refers to that ‘industrial mutation’ process, which continuously changes a nation’s economic structure; involving annihilation of old ones and the creation of new ones. Destruction occurs with the purpose of a new creation. Schumpeter regarded creative destruction as an important and inherent part of capitalism. Creative destruction recognizes the contribution of the process of technological innovation to an economy’s growth. The capitalist process is characterized by this evolutionary phenomenon. Factors like the emergence of new consumers, new types of industrial organizations, new transportation and production techniques and new market structures to name a few fuels that basic impulse, which keeps the engine of capitalism running.
Creative destruction has interesting connotations in the US economy of 2008 faced with financial market volatility and economic dire straits. For instance, followers of creative destruction theory may hail fall of Lehman a normal event; an inefficient financial institution has fallen only to release capital for migration to some brand new efficient institution. However, this will have some spillover effects for developing economies. Two important issues here, are financial sector regulations and closing of ‘export-led’ growth. Financial sector regulations in the form of increased democratization in a host of emerging markets have been observed. Middle class people are also seen to indulge a lot more in equity investment activities. However, these markets are devoid of some complex financial instruments, which are offered on Wall Street. If however, current US recession is in for a substantially long period of time then this will only strengthen the case for mild government financial market regulations. Export-led growth, typical of most Southeast Asian nations will cease to be less viable for developing nations after this financial mess in America. Events like fall of Lehman, sale of Merrill Lynch and financial problems faced by AIG will only further contribute to global slowdown including that of developed nations.
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This glossary post was last updated: 4th August, 2021 | 2 Views.