Joseph Schumpeter, creative destruction, and the signficance of business strategy

Artificial Intelligence (AI), the way it has progressed in the past few years, has surprised me, like many of you. And yet, it feels like a dejavu. It feels as though I have been here multiple times before. It felt uneasy to see many people in my neighborhood lose their jobs in the 1980s as cotton mills in Bombay (now Mumbai) shut down. Both my father and father-in-law were either forced to retire or lost their jobs. Today, we have super-tall buildings in their place in the Prabhadevi-Parel area, including one Trump Tower. Then came PCs and the Internet in the 90s. In 1991, Bill Gates announced that "Kodak is toast" at the Buffett Group gathering. It took time, but slowly most Kodak film studios in my neighborhood vanished. This was followed by the mobile revolution, and the landline monopoly of BSNL crumbled. Gone are the days when one could wave a hand and an auto/taxi would stop. The person who said that this phenomenon, which he called "creative destruction", is at the heart of capitalism is Joseph Schumpeter. A study of capitalism that ignores creative destruction is like "Hamlet without the Danish prince," said Schumpeter in the closing line of chapter 7 of his most famous book, "Capitalism, socialism, and democracy" (CS&D), published in 1942. What was Schumpeter trying to say in this chapter titled "The process of creative destruction"? And how does it relate to business strategy? Let's explore this in this article.

Schumpeter wrote CS&D from 1939 to 1942 while he was a faculty member at Harvard. He had just finished writing a massive treatise called "Business Cycles". It was published in 1939 in two volumes totaling 1095 pages. In 1941, he was invited to The Lowell Institute in Boston to deliver eight public lectures on "An economic interpretation of our times". This is where he first presented the ideas he had been working on that became CS&D. This was a turbulent period in Schumpeter's life. He was disturbed by the war in Europe. Moreover, in 1941, he was under investigation by the FBI for possible espionage, and he was ostracized in the social circles of Cambridge. He had begun to scrutinize his life and felt he was "worthless", "frivolous", "vain", and a "snob", and his life had been "a failure". It is remarkable to see someone produce such a marvelous book under such circumstances.

Who was Schumpeter responding to when he wrote CS&D, particularly the creative destruction chapter? This chapter is in Part II of the book entitled "Can capitalism survive?" In the first few chapters of Part II, Schumpeter is presenting his view of how contemporary capitalism works. He felt that most economists treated the economy as static and competition as perfect. Schumpeter felt that the economy is an evolutionary process. He says, "The essential point to grasp is that in dealing with capitalism we are dealing with an evolutionary process." He gives credit to Karl Marx for emphasizing this aspect. Thus, he is primarily responding to the economists who treat the economy and capitalism as a static entity. Schumpeter says, "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 new forms of industrial organization that capitalist enterprise creates."

Schumpeter says due to this process of creative destruction, competition is an "ever-present threat" even though a business may be a monopoly or a part of an oligopoly. He illustrates his point with the example of retail trade. "In the case of retail trade the competition that matters arises not from additional shops of the same type, but from the department store, the chain store, the mail-order house and the supermarket which are bound to destroy those pyramids sooner or later."

One implication of this evolutionary process undergoing "industrial mutation" from time to time is that "there is no point in appraising the performance of that process ex visu of a given point of time; we must judge its performance over time, as it unfolds through decades or centuries." The second implication is that "since we are dealing with an organic process, analysis of what happens in any particular part of it - say, in an individual concern or industry - may indeed clarify details of mechanism but is inconclusive beyond that." Schumpeter is saying that we shouldn't be analyzing the impact of AI on one company or sector; the effect is likely to spread to the entire economy over time. 

This is where Schumpeter brings in the role of strategy. The term "business strategy" wasn't as fashionable then as it is now. Schumpeter says, "Every piece of business strategy acquires its true significance only against the background of that process and within the situation created by it. It must be seen in its role in the perennial gale of creative destruction; it cannot be understood irrespective of it or, in fact, on the hypothesis that there is a perennial lull." The primary purpose of business strategy, according to Schumpeter, is to watch out for strong winds or waves - technological, regulatory, fashion, demographic - that are likely to disrupt the business and to prepare the organization to ride them with appropriate responses. 

I found the chapter "The process of creative destruction" both readable and quite significant for today's context. Eighty years after this chapter was written, many of us still feel ill-prepared to face the strong winds of AI and automation.

Sources:

"Capitalism, socialism, and democracy," Joseph Schumpeter, Routledge, 1994 (chapter 7)

"Prophet of innovation: Joseph Schumpeter and creative destruction", Thomas McCraw, Harvard University Press, 2007 (chapter 21)

Related articles:

A century of innovation economics: Schumpeter's 5 types of innovations, April 6, 2010
Joseph Schumpeter and the principle of indeterminateness, December 9, 2013