Creative Destruction—The Best Game in Town

A market economy is a profit-and-loss system

By Robert Higgs  

In his justly famous 1942 book Capitalism, Socialism and Democracy, Joseph A. Schumpeter described the dynamics of a market economy as a process of “creative destruction.” In his view, innovation—“the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates”—drives this process. Its most important result is that for the first time in history, the mass of the population in developed countries enjoys a standard of living that even the aristocrats of past ages could scarcely have imagined, much less have actually had.

Yet, as Schumpeter sought to express by his pithy term, the process is not merely creative, but also destructive. As a market economy develops, it necessarily brings about an immense variety of changes in particular demands and supplies, and hence it results in losses as well as profits. For those who rely on selling goods or services in declining or disappearing demand, for those whose locations no longer fit well into emerging spatial patterns of production, for those whose techniques of production no longer represent a means of maximizing net revenues, for those whose skills and experience no longer attract eager buyers in the labor markets—for them and countless others, the process of economic development brings anxiety, disappointment, loss, and in some cases ruin.

The losers take little solace in the thought that their economic displacement or demotion by more competitive workers and producers constitutes the heart and soul of a process by which the entire society, on average, becomes richer. And their plight has always attracted legions of critics who correctly blame the market system for the wreckage. It is simply impossible for the process of economic development to operate without losers. A market economy is a profit-and-loss system. Profits signal the desirability (to consumers) of moving resources to new employments; losses signal the desirability (to consumers) of removing resources from current employments. On the one hand, people are drawn by the prospect of heightened economic pleasure; on the other hand, they are repelled by the onset of persistent economic pain. In this way the overall system continually reshapes itself to comport more effectively with the prevailing patterns of demand and supply.

For the losers, the perceived remedy of their plight has often been not to make the necessary personal adjustments as well as possible, but to use force, especially state force, to burden or prohibit the more successful competitors in the market. Thus, the market’s critics demand bailouts, subsidies, tax breaks, and corporate and personal welfare of various sorts to soften the blows of the Schumpeterian “perennial gale of creative destruction.” Notice, however, that all such attempts to soften the blows also serve to mute or falsify the messages the market system is sending about where resources can be employed most productively in the prevailing circumstances. Amelioration of the suffering softens the blows, to be sure, but it also slows the process by which wealth is being created and introduces wasteful measures that may, especially if they are state-mandated, become entrenched in the politico-economic system and thereby serve as channels for resource waste and as permanent fetters on real progress.

Many critics, of course, have called not for ameliorative measures, but for wholesale abandonment of the market system and its replacement by socialism, fascism, or some other form of state direction of the economic order. For the past two centuries the debates between pro-market and anti-market champions have raged continually with no sign of a final resolution in sight. Nowadays, however, the market’s critics call less often for across-the-board abandonment of the market and more often for greater or lesser state intrusions into its fundamental institutions—secure private property rights and genuine rule of law. If enough such partial intrusions accumulate, however, as they have over the past century or more, the system becomes less a market system deflected here and there by the state, and more a state-dominated system deflected here and there by entrepreneurs who operate, legally or illegally, in the system’s remaining market-oriented interstices.

In this de facto fascist environment, the resource wastes and misallocations become a growing burden on the system’s capacity to generate a high rate of economic growth, indeed, ultimately on its capacity to produce any additions to real wealth. Such overburdened economic orders eventually die a slow death as their vital arteries of innovation and private investment become clogged by subsidies, taxes, regulations, direct state involvement, and other anti-productive buildups. The system then must endure not simply the frustrations and relative impoverishment of a succession of (often only temporary) losers in the process of creative destruction, but the frustration and absolute impoverishment of everyone except perhaps a fortunate few who benefit from the state’s channeling loot to them.

What are we to conclude, then, about the process of creative destruction? The main conclusion must be that however painful it may be for those who must make the wrenching adjustments required by the economy’s technological progress and changing structure, that pain plays an essential role in motivating the resource reallocation and other adjustments—for example, changes in the types of education, training, and experience people acquire—that make possible an ongoing process of economic development in which, in the course of time, nearly every member of society will be better off. Turning to the state, either for endless ad hoc intrusions or for across-the-board replacement of the market-directed economic order, may eliminate some of the pain associated with the process of creative destruction, to be sure, but only by replacing that process with one of uncompensated destruction, suffocating innovation and other forms of economic creativity and bringing real economic progress to a grinding halt.

It is a sorrowful reality that for the past century or more, people in the West have for the most part turned increasingly away from the economic system whose creativity redeems it and embraced instead systems whose hallmarks are economic irrationality, resource waste, bureaucratic tyranny, and ultimately mass impoverishment. Perhaps the great economic advances in Asia, where the market has been given wider scope in recent decades, will serve as a lesson to Westerners, pulling them back before they allow their governments to plunge them into the mass poverty from which their ancestors pulled themselves by means of the market system in earlier centuries.