Thwarting creative destruction

Last updated on: March 19, 2009 at 6:10 am by Gene Veith

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Thwarting creative destruction 2009-03-19T06:10:57-04:00 Gene Veith

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Logan Delany reminds us that free markets must both build and destroy, and that thwarting the “creative destruction” of failed businesses does not help the economy. Emphasizing that our economy is going through a transition into a global, “digital” economy, Delany applies the insights of a classic economics text into why a recession can be a good thing:

The economy must reallocate capital and labor from the old economy to the new economy. Joseph Schumpeter best described how recessions contribute to the structural evolution of an economy as “creative destruction” in his classical book “Capitalism, Socialism and Democracy.”

When the economy is strong, marginally productive manufacturing facilities, retail outlets and financial services continue to function because they contribute profits to a business´s bottom line by providing goods and services to consumers. In tougher times, the least productive of these operations become unprofitable and redundant.

The classic textbook example of this phenomenon is the buggy-whip manufacturer at the turn of the 20th century. When automobiles were replacing horses and buggies as the primary means of transportation, who needed buggy whips? At the turn of the 21st century, is there a place for unprofitable automobile companies that are being abandoned by customers who want cars with better fuel efficiency, quality and styling at a lower price than these companies provide? Is there a place for the manufacturer of analog TVs in today’s market? Does the economy really need Circuit City stores when consumers abandoned them for Best Buy? The market will decide.

Most people make hard decisions only when forced to do so. Business people and politicians are no different. In a recession, business people are forced to make tough decisions when they are losing money.

If there are no markets for their products, they must downsize or close their factories that are losing money, or they go out of business. Employers are distraught when faced with the decision to terminate competent and fiercely loyal employees, but the marketplace leaves them no choice if the survival of the business is at stake. The recession always forces these decisions. In the long run, the economy is better off because capital and human resources are no longer wasted on obsolete buggy-whip manufacturing but are allocated to more productive new technology.

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