Joseph Schumpeter considered the process of creative destruction to be the fundamental, defining characteristic of capitalism, not merely a side effect. He argued that this continuous cycle, where new innovations displace old technologies and firms, is the core engine of economic progress within a capitalist system, rather than an occasional disruption.

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Creative destruction is the market process where new technologies and the firms that implement them supersede older, less efficient ones. According to Joseph Schumpeter, firms that fail to adapt are displaced because they are unable to compete; their higher production costs prevent them from selling goods at a profitable market price. Schumpeter considered this process 'creative' because the failure of these unprofitable businesses releases labor and capital, making these resources available for reallocation into new, more innovative firms and production methods.

Creative Destruction Definition

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CORE Econ - The Economy 2.0: Microeconomics

According to economist Joseph Schumpeter, the temporary innovation rents earned by entrepreneurs are a key driver of capitalism. However, these rents are eroded over time. When competitors observe these profits, they are incentivized to adopt the new, lower-cost technology. As these firms thrive and increase their output, the total market supply of the good expands, leading to a fall in its price. This process continues until the innovation rents are completely competed away. At this point, firms that have not adapted and are still using the old, more expensive technology will find themselves unprofitable and be forced out of the market. Schumpeter termed this process 'creative destruction,' viewing the failure of these firms as 'creative' because it releases labor and capital, allowing these resources to be reallocated to new, innovative combinations.

Schumpeterian Rents and Creative Destruction

Creative Destruction as the Essential Fact of Capitalism

In a competitive capitalist market, there is no assurance of long-term success. To remain ahead of rivals and avoid being driven out of business, firms must engage in a continuous process of innovation.

Constant Innovation as a Requirement for Market Survival

Schumpeter argued that the decentralized process of creative destruction is fundamentally beneficial, or 'virtuous.' He contended that by enabling the continuous replacement of old firms and technologies with new, more efficient ones, this process drives sustained improvements in productivity, which is the engine of economic growth.

Creative Destruction as a Virtuous Process for Economic Growth

The process of creative destruction, involving the failure of old firms and the rise of new ones, is not instantaneous. According to Schumpeterian theory, this inherent slowness in reallocating resources and establishing new enterprises is a primary cause of the economic upswings and downswings (business cycles) that characterize capitalist economies.

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