Just a decade ago, the smartphone sector was ruled by big dogs like Motorola, Nokia, Palm, and Blackberry. Before 2007, no one in that sector gave computer companies like Apple and Google much of a thought.
Then came the iPhone and the Android operating system. Within a few short years, Google and Apple had almost totally displaced the old phone giants, and they got very rich doing so.
That kind of turbulence is the new normal in our modern global economy. Innovators seem to constantly come out of nowhere to displace yesterday’s giants — only to immediately face threats of their own from still more scrappy upstarts.
That kind of turbulence is the new normal in our modern global economy.”]
Put simply, we live in Joseph Schumpeter’s economy now. That Austrian-born economist famously called this state of productive upheaval the “perennial gale of creative destruction.” We can see this gale reverberating throughout the modern world, and many people now finally appreciate the crucial role of entrepreneur in this process — something Schumpeter made central to his theory of economic change.
Indeed, on the occasion of his 134th birthday, we continue to see Schumpeter’s insights and influence all around us. Thomas K. McCraw began Prophet of Innovation, his magisterial biography of Schumpeter, by noting that “Schumpeter’s work was so powerful that today’s thinking about capitalism is in large part his — specifically, his emphasis on innovation, entrepreneurship, business strategy, and ‘creative destruction.’”
Elevating the Entrepreneur
While almost every economics program and business school promotes the centrality of entrepreneurialism to economic growth today, when Schumpeter was writing on these topics in the pre–World War II period, the entrepreneur was largely a forgotten figure in the simplistic neoclassical economic models of the day.
Schumpeter swung an intellectual sledgehammer at those models and demolished them. Against those textbook theories and their simplistic obsession with static “equilibrium” and “perfect competition” end states, Schumpeter forcefully argued that economic change was instead “an organic process” that “never can be stationary.” Instead, he said, disequilibrium was the real key to the “this evolutionary character of the capitalistic process.” As Schumpeter explained in his 1942 masterwork, Capitalism, Socialism and Democracy:
in capitalist reality as distinguished from its textbook picture, it is not [perfect] competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization … competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.”]
“This kind of competition is as much more effective than the other as a bombardment is in comparison with forcing a door” he argued. This is because the “ever-present threat” of dynamic, disruptive change “disciplines before it attacks.”
Again, the spark that continuously reignites this process is the entrepreneur, who is always itching to do things different and better. “The function of entrepreneurs,” Schumpeter made clear,
is to reform or revolutionize the pattern of production by exploiting an invention or, more generally, an untried technological possibility for producing a new commodity or producing an old one in a new way, by opening up a new source of supply of materials or a new outlet for products, by reorganizing an industry and so on.”]
Real Competition and Choice
Schumpeter could have been describing any number of modern innovators who have pursued “an untried technological possibility” and ushered in one wave of creative destruction after another. Consider Uber, Airbnb, and the “sharing economy” more generally. A decade ago, no one had even heard of those companies or that term. Today, those two companies have a combined worth of $99 billion and have upended the sleepy old sectors of taxi cabs and hotel rooms.
Who could have seen it coming? Certainly not all the state and local policy-makers who had spent decades micromanaging the transportation and hospitality sectors in the hope of somehow serving “the public interest.” Alas, all that they gave consumers was higher costs, less choice, and a whole lot of cronyism.
It was only when Schumpeterian creative destruction entered the scene that things started to improve. By doing an end-run around the regulatory state, sharing-economy entrepreneurs have given the public their first taste of what real competition and choice look like.
It was only when Schumpeterian creative destruction entered the scene that things started to improve.”]
But even skilled business analysts and industry experts were caught off guard by these rapid changes. Most of them had taken their own static snapshot of those markets and not expected highly disruptive change to take hold any time soon.
Of course, some people are just never happy, and now some policy-makers and regulatory-minded academics worry that new tech innovators are getting too big too quick, and they regularly lament what they regard as “monopolies” in the making.
But Schumpeter had an answer for that complaint, too. He explained that uneven entrepreneurial gains — even supranormal short-term profits — must be tolerated if innovation is to occur. Innovators will only take risks if they can expect the potential for big gains from it. Attempts to curtail those potential benefits through hasty regulatory interventions or antitrust threats will sap the entrepreneurial spirit from the marketplace, limit technological innovation, and diminish the possibility of greater market dynamism and consumer choice over the long-haul.
“In this respect,” Schumpeter concluded, “perfect competition is not only impossible but inferior,” precisely because it would sabotage “the most powerful engine of that progress … those entrepreneurial profits which are the prizes offered by capitalist society to the successful innovator.”
The modern smartphone sector with its rapid innovation in devices and apps, validates this crucial insight.
The pursuit of enormous potential profits is what fueled Apple’s and Google’s original daring dive into the risky waters of a seemingly stable and unassailable smartphone sector in the mid-2000s. And then the pursuit of profitability spawned a whole new constellation of “app” providers, who now give consumers access to millions of new mobile services at little to no cost.
But again, Schumpeter had all this figured out 75 years ago when he noted that there was no discernable end point to the process of entrepreneurial-driven change.
To survive, even the most successful companies have to be willing to quickly dispense with yesterday’s winning business plan before it is obliterated by the steamroller of relentless technological change and rapidly shifting consumer demand.
Surprises are always right around the corner — yet they will only emerge if innovators are free of artificial constraint by government forces, which are always one or two steps behind fast-moving technological developments.
It is for reasons like this that Schumpeter has such a diverse fan base these days. If anything, he perhaps commands too much attention relative to the many others — especially F.A. Hayek and Israel Kirzner — who also made essential contributions to “dynamic competition” theory and our understanding of the role that entrepreneurs play in catalyzing innovation and economic growth.
But Schumpeter’s legacy is rightly cemented into the foundations of modern economics and business theory because, better than anyone before or since, he so eloquently defined and defended the inherently dynamic nature of economic change and spontaneous entrepreneurial activity.
Of course, Schumpeter also feared that capitalism might sow the seeds of its own destruction by creating constituencies opposed to those continuous waves of disruptive change. To be sure, that’s an ongoing concern in our current era, as opposition to globalization and technological change seems to be gaining steam once again.
Yet, the resiliency of the modern economy and the ongoing ingenuity of the innovators who continue to push it forward serve as a continuing testament to Schumpeter’s dynamic vision of economic progress and prosperity.