Schumpeter’s Creative Destruction

Doc’s note: Today, I’m sharing an essay from famed political satirist P.J. O’Rourke. In a recent issue of his online magazine, American Consequences, P.J. explains the common sense of the free-market system and the danger of undermining it.

American Consequences is edited by P.J. and written by some of the smartest contrarian market analysts in the world. The best part is… it’s 100% free. There’s no subscription fee or “paywall.” Sign up to start receiving issues right here.

The amazing thing about free-market capitalism is that it gets rid of stuff that doesn’t work. You say, “Amazing? When stuff doesn’t work, of course you get rid of it!”

If you’ve got a washing machine and – no matter how many times the supposedly lonely Maytag Man has been to your house – it just can’t be fixed… do you keep piling dirty clothes into it? You’ll run out of things to wear.

No, you haul the old appliance to the dump and acquire a new one. This is what free-market capitalism does with businesses. When a business is no longer profitable, investors dispose of it and put their investment capital into another business that does (or will, investors hope) make a profit.

(Which is pretty much what happened to Maytag – the brand name bought by Whirlpool and practically everybody at the Maytag company fired.)

This is – sorry, Maytag employees – common sense. And common sense is really all there is to the free-market capitalist system.

But there are other systems… systems that don’t involve common sense in the use of capital, systems that spend money in strange and silly ways.

Of these systems, the biggest is big government, with its ethos of “If it works, tax it… If it doesn’t work, subsidize it.”

When the government has a broken washing machine, it breaks the dryer to ensure job security for the Maytag Man, then funds a grant program for free clean t-shirts.

Or, to take an actual example, there’s the War on Poverty. The federal government has spent hundreds of billions of dollars on poverty programs. (It’s currently spending more than $668 billion a year, according to the Cato Institute.)

The War on Poverty began with LBJ’s Great Society initiative in 1964. For a while it worked. The U.S. poverty rate was 19% in 1964. By 1974, it was 11.2%. But over the next 45 years, the poverty rate had… a poor run. In the midst of the present economic boom, in 2017 (the latest figures available), the U.S. poverty rate was 12.3%.

If poverty were a business, we’d all be broke.

This common sense of the free-market capitalist system is obvious. So, obviously, it was the first thing economic theorists noticed about free markets when they began studying capitalism in the late 18th century.

Not.

It wasn’t until the brilliant Austrian economist Joseph Schumpeter (1883-1950) published his book Capitalism, Socialism and Democracy in 1942 that economists’ attention was drawn to the common-sense fact that abandoning what doesn’t work is what makes what works work.

Schumpeter called this process “creative destruction.” It’s been a catch phrase to describe business cycles ever since. He made it sound more complicated than it is:

Capitalism… is by nature a form or method of economic change and not only never is but never can be stationary… 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 process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.

Schumpeter thought that creative destruction was so creatively destructive that it would, in the end, create the destruction of capitalism itself by undermining capitalism’s institutional framework, that framework being common sense. If we allow common sense to be undermined – and big government is down in that mine working hard with picks and shovels – Schumpeter’s point will have been proven.

But the real lesson of Schumpeter is that uncommonly brilliant economists are not uncommonly sensible. They are odd men who can see the inside intricacies of an economy but take more than 175 years to look that economy in the face – watchmakers who understand every spring and gear of clockwork but who can’t tell time.

And Schumpeter himself was an odd man. In his diary, he set himself three goals – to be the greatest economist in the world, the greatest horseman in Austria, and the greatest lover in Vienna. He claimed to have achieved two out of three goals but didn’t say which two…

Sincerely,

P.J. O’Rourke