Introduction
Creative destruction is a term used “to refer to the incessant product and the process innovation mechanism by which new production units replace outdated ones” (Schumpeter 81). Backhaus writes that “the term creative destruction is the oxymoron of creation and destruction; it appears to be a paradox. But what it means is to create the new and destroy the old and the new and the old are not on the same dimension” (Backhaus 600). Creative destruction, explain Acs and David, “is the view of the market process as the elimination of the old way of economic life, not as the achievement of a Paretian equilibrium, and the view of the dynamic efficiency of monopolistic firms are also corollaries of the conception of creative destruction and understandable in this wide perspective”(Acs and David 101).
Creative Destruction & Finance
The process of economic restructuring, write Bodvarsson and Henrik, “permeates major aspects of the microeconomic performance, not only long-run growth but also economic fluctuations, structural adjustment and the functioning of factor markets” (Bodvarsson and Henrik 246). It is important to note that creative destruction happens both at a micro and macro level. At the micro-level, write Kalvet and Rainer, “economic restructuring is characterized by decisions to create and destroy production arrangements. These decisions are often complex, involving multiple parties as well as strategic and technological considerations. The efficiency of these decisions not only depends on the managerial talent but also on the existence of sound institutions that provide a proper transactional framework.” (Kalvet and Rainer 28). Failure to effectively restructure at the microeconomic level, writes Beije, “ impacts innovation and macro level economic growth. This has to do with the fact that innovations in one industry may impact the economic growth in one or more other industries” (Beije 98). This means that failure to properly restructure micro-level wealth destruction can lead to a macro-level market failure. The sources of failure at the micro level can arise from different sources. These failures can be either natural or induced by wrong business ideas. Some of the human causes of micro-economic failure include “ill-conceived economic ideas to the achievement of higher human goals, such as the inalienability of human capital” (Beije 111). Failure at a macro-level can lead to the complete market failure or a complete stagnation of the economy.
For innovation to be regarded as efficient there has to be adequate resources that have been invested. This means that even though a given innovation is prone to negative externalities, there is a possibility of restructuring, the remaining resources after a destruction, to come up with another working project. Investing optimally, in terms of resources, in a given investment allows the availability of spillovers in case there are damages to old wealth. Nolan and Croson write that “substantial spillovers that yield a large proportion of the benefits to others rewards all those involved in the innovation process after damage has occurred. Those beneficiaries include not only the general consuming public but, often, direct competitors of the innovators. Because the rewards to the innovator are thereby reduced, perhaps severely, the resulting innovative activity can be expected to be less that optimal” (Nolan and Croson 29).
The nature of the innovation is also a determinant of the type of externalities that are likely to face the market both at micro and macro level. Though the optimal investments resources in a given innovation might seem like a constructive business idea, the fact remains that any type of innovation “generates a social cost that is not borne by the investor. Consequently, the innovator can be expected to disregard them and invest more in innovation that is justified by their social cost. In short, the innovation activity may be excessive, rather than inadequate” (McKnight 23).
Many theories have been put across with the aim of determining the reason behind economic growth even after a damage has occured. All theorists have pointed back to the theory of creative destruction invented by Schumpeter. Recent research has shown that innovation is not subject to both negative and positive externalities but can be a source of its own externalities. Theorists argue that because innovation comes with a social cost, it makes innovation be a source of negative externalities by itself. In addition, innovations can be a source of externalities if they do not have any spillovers. Innovations whose spillovers after damage end up being zero are in themselves negative externalities. The main reason why an innovation whose spillover is zero might be regarded as being externalities is due to the fact that every financial transaction has to have a tradeoff. Therefore, an innovation that lacks a spillover does not respond to this theory because there has to be trade-off between the capital that goes into the investment of a given innovation, and the benefits that are reaped from it.
Spillovers are not measured in terms of their quantity but in terms of their relative ratio to the capital inflow that goes into the investment process. McKnight writes that “ the range of values of the spillover ratio is “the share of the benefits of innovation that goes to persons other than the investors, within which all values of the ratio are Pareto-optimal in the absence of any possibility of lump-sum transfers. They are all subject to a constraint of rules out hypothetical but totally infeasible re-distributive arrangements” (McKnight 24). Innovators should work towards making the spillover to be above zero because substantial gains cannot be reaped from an economy or a business enterprise after damage. Innovation is the source of livelihood for many people. This is because without innovation spill over, the standards of living of both the consumer and the investor are affected. The amount of wages that an innovator directs to his employees depends on the spillover that is derived from a given enterprise. Therefore, when there is minimum spillover from a given business, then there is a risk that the amount of wages is going to decrease or not be available at all. The lack of wages especially at a macro-level, when talking about the economy, would mean that consumers would have a lower purchasing power. A lower purchasing power in the part of the consumer would mean that even the innovator would be forced to exit the market because the marginal profit derived from a given enterprise is reduced.
It is worth to note that spillovers are not only important to both the innovator and the consumer but it is also beneficial to society. This is due to the fact that business enterprises and the economy at large extend benefits to the society. Companies sometimes address immediate problems facing a given society. Some of the social benefits reaped from the business world involve, the sponsoring of community related activities for example education, environmental protection, women empowerment, children affairs among other things that are considered as being important part of the social facet of society.
The industrial revolution in itself was a form of creative destruction. The industrial revolution brought about technological and production changes within the society. This left many people unemployed. However, increased unemployment did not mean stagnation in the economy. This is because the spillover that had been generated from prior innovations ended up benefiting the people who lost their jobs thereby creating a scenario whereby the people who were losing their jobs due to the adoption of technology still benefited. This means that the standard of living of people cannot be improved unless there is a spillover from recent innovations.
Many scholars have attempted to answer the question of why a given society would continue succeeding even after facing damages or economic meltdown. The idea of creative destruction remains the answer for this question. Societies continue to embrace capitalism which allows both innovators and consumers to enter and exit the market at their own will. This kind of business environment allows the economy of different states to continue growing and increasing in size. Policy makers, with the intentions of improving the standards of living of a given society, tend to use the market theory that works best. For example, in the People’s Republic of China, capitalism seems to be working in the absence of democracy. This means that innovation works differently in different societies. All that matters in long run is that there is a spillover of the economy which allows the innovator, the consumer, and the society at large to benefit from the economy in the long run.
Creative destruction in a capitalist market.
In his book, Capitalism, Socialism, and Democracy, Schumpeter writes that creative destruction is a process. Schumpeter explains that creative destruction had its initial traditional form but assumes a more contemporary form today (Schumpeter 41). Schumpeter explains that both, the traditional and contemporary, forms of creative destruction are sources of innovation. Both forms of creative destruction are governed by the standard model price which allows the economy to compete at a micro-level. Schumpeter sees capitalism as the real source of innovation. Without capitalism, it is difficult for innovations to effectively maneuver through the business environment. Carl Marx just like Schumpeter believed in this dynamism of the society. Carl Marx believed the society evolved over time. Though Schumpeter is receptive of the Marxist theory, the fact that innovation works best in a dynamic society is in line with his theory of creative destruction. Another similarity that exists between Marxism and Schumpeter’s theory of creative destruction is that both theories concur that capitalism was indeed a fragile economic model. However, Carl Marx was quick to bring about socialism theory to completely substitute capitalism in that he believed that capitalism would not work in its pure form. On the other hand, Schumpeter’s creative destruction theory sought to look at capitalist more closely so as to seal it weak areas. Some of these areas included increasing the spillover of a capitalist economy so as to avoid the risks of market failure. This move by Schumpeter was meant to prevent many economic models from buying into the idea of socialism because the adoption of such an economic model would lead to the demise of capitalism.
Capitalism has been perceived by many scholars as being one of the best economic models because it has been workable in most of the large world economies. One important thing to know about capitalism is the way it works and the way it leads to the growth of the economy or a business enterprise at a micro-level. First of all, capitalism creates an environment of new ideas. These ideas result into new innovation. This means that within a capitalist market there is continued motivation to invest which eventually leads to a continuum in the increase of new wealth. In a capitalist market, writes Dolan, “the fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumer goods, the new methods of production or transportation, the new markets, and the new forms of industrial organization that capitalist enterprise creates”(Dolan 43).
Schumpeter’s theory of creative destruction maintains the stopping the invisible hand of capitalism is almost impossible. This is because capitalism continues to evolve due to the dynamism of today’s society. In addition, more capital continuous to be invested on different innovations which means that stopping capitalism would hinder economic progress and overall growth. Capitalism involves both material investment and progress which makes any efforts to stop the invisible hand of capitalism to pose the risk of causing detrimental consequences to the economy. Hindering the progress of capitalism would reduce the funds flowing into particular material investments. In such a case, funds end up being used for unintended purposes. This often leads to a deficit which if not properly managed can lead to substantial economic decline.
Creative destruction as a design
Though the concept of creative destruction might appear as being complicated, the fact remains that it mirrors the nature of our current national economies that are able to bounce back after economic meltdowns. Creative destruction is aimed at enhancing both social progress and social change within the society. This is because innovation is a fundamental requirement of a country’s economic growth at the macro level and also maximizes the net profit at the micro level of society. Economic empowerment of the society is the source of societal change. Innovation institutes change within the society by making sure that the innovator, the consumer, and society at large stands to benefit even in the case of economic damage. This is made possible by the fact that creative destruction encourages the maximization of spillover.
It is important to realize is the creative destruction is designed in such a way that it evaluates the economic developments that are taking place in given society. This helps to determine whether the developments are well managed so as to maximize either the economic gains or the net profits generated by a business enterprise. The theory of creative destruction makes the assumption that every idea that is aimed at maximizing profit should be embraced and evaluated in order to assess the risk. Weber writes that “every piece of business strategy acquires its true significance only against the background of that process and within the situation created by it. It must be seen in its role in the perennial gale of creative destruction” (Weber 131).
Conclusion
In conclusion, creative destruction theory argues that old wealth can always be substituted by new wealth. However, for this to happen, there must be high levels of innovation and investment which makes sure that the spillover level is above zero. A high spill over, either in the economy at both a micro and macro level, allows the innovator, the consumer and the society at large to benefit from a particular material investments. In addition, proper resource management is required if old wealth is going to generate new wealth. Failure to employ the necessarily management skills can lead to a complete market failure or a detrimental economic stagnation.
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