Entrepreneurship: Creative Production, Not Creative Destruction
Fifty years ago, I added a subtitle to the manuscript of my book, published the next year, Marx's Religion of Revolution: The Doctrine of Creative Destruction (1968). I changed that subtitle two decades later in the revised edition: Regeneration Through Chaos. I changed the cover, too.
There was a doctrine of creative destruction in the 19th century. Karl Marx's rival, the revolutionary anarchist Michael Bakunin, promoted it. He was a revolutionary. He saw worker violence against the state as productive. But Bakunin was as hostile to the free market as he was to the state. He never described how the division of labor economy could operate with neither central planning by state bureaucrats nor the market's process to guide resource allocation. Neither did Marx, who never described his supposedly inevitable final social order, communism.
The phrase "creative destruction" was popularized by the Austrian, but not Austrian School economist, Joseph Schumpeter. He was a contemporary of Ludwig von Mises. They both studied economics at the University of Vienna. Schumpeter described the entrepreneur in capitalism as a creative force in society. There was nothing new about this insight. Austrian School economists have long described the entrepreneur in these terms, including Mises. But the heart of entrepreneurship analytically is not destruction; it is customer satisfaction.
Schumpeter added the word "destruction" to describe entrepreneurship. Wikipedia's entry for "Creative Destruction" says:
Creative destruction (German: schöpferische Zerstörung), sometimes known as Schumpeter's gale, is a concept in economics which since the 1950s has become most readily identified with the Austrian American economist Joseph Schumpeter who derived it from the work of Karl Marx and popularized it as a theory of economic innovation and the business cycle.According to Schumpeter, the "gale of creative destruction" describes the "process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one". In Marxian economic theory the concept refers more broadly to the linked processes of the accumulation and annihilation of wealth under capitalism.
Marx had it wrong. So did Bakunin. So did Schumpeter.
BUY LOW, SELL HIGH
A successful entrepreneur buys low and sells high. But how can he do this if the free market pays full value to every factor of production, something that neoclassical economists teach? For him to buy low and sell high, there would have to be mispriced resources. The answer is simple if you are an Austrian School economist. The free market's system of competition does reveal specific mispriced resources. Entrepreneurs perform this crucial service to customers. Austrian School economists begin with this presupposition: people are not omniscient. They do not recognize every mispriced resource. There is always ignorance in the market. Austrian School economists insist that economic theory must rely on a concept of market pricing that is based on incomplete and inaccurate information.
So, there are always underpriced and overpriced resources out there. The free market reduces the number of underpriced resources by two profit-making arrangements. The first is capital markets. Entrepreneurs can buy factors of production, mix them, and offer products for sale to customers. If customers buy at a price that is higher than the cost of production, the entrepreneur reaps a profit. If they don't, he reaps a loss.
This stems from a fundamental uncertainty in human affairs. We do not know the future. But some people think they know it better than their competitors. They bear the costs of uncertainty by buying resources and producing products for sale. This uncertainty is inescapable. It is imposed by the human condition. People are not omniscient.
There is another institutional approach, which is related analytically. The entrepreneur, now called a commodity futures speculator, enters a specific resource market. For underpriced resources, he "goes long." He promises to buy a specific quantity and quality of a resource at a specific place on a specific date. For overpriced resources, he sells short. He promises to deliver the resource at a specific place on a specific date at a specific price. In a commodity futures market, shorts and longs make contracts with each other. This is a zero-sum process. The winner wins at the expense of the loser. But this arrangement is not a game. Futures speculators are dealing with real-world problems related to uncertainty: the unknown economic future. They are not in a rigged game of statistical chance created by casino owners to get rich.
The commodity futures market is a voluntary arrangement that promotes price discovery, which benefits hundreds of millions of market participants. Yet these buyers and sellers do not pay for this process of price discovery. They are "free riders" on the futures market. The speculators -- longs and shorts -- pay for the entire process. There is nothing destructive about this arrangement, contrary to market-hating critics of speculators. The commodities futures market is one of the great institutions in modern life. A handful of winners and losers put their money on the line. The rest of us don't pay them a dime for this crucial social service: price discovery.
WINNERS AND LOSERS
In an entrepreneurial venture, someone buys scarce production goods. He thinks customers in the future will pay more than his competitors think is likely. He buys productive resources -- labor services, raw materials, factory space, specialized tools of production, and storage space -- to create products. He buys lower than customers are willing to pay for finished products, he hopes. How is this possible? Because his competitors do not see the opportunity. They do not bid up the prices of these factors of production.
The entrepreneur buys resources. This helps all those resource owners who sell to him at a voluntary market price. If this did not help them, they would not sell. His production also helps customers. If he had not gone into production, no one else would have. No competitor saw the opportunity. So, he was able to put resource owners together with customers who were willing to pay for the output of these resources.
Why is this destructive, creative or otherwise? It isn't destructive for sellers and buyers of resources. It is destructive only for rival entrepreneurs who did not see the opportunity. They now see a market taken away by a competitor. This competitor starts making profits. If this same entrepreneur keeps making profits, the competitors will lose market share. "This is destructive!" they cry. For them, it is. But the free market social order is not supposed to help unsuccessful forecasters. It operates to help customers get better deals, as determined by paying customers.
Schumpeter picked up the lament of the inefficient entrepreneurs who missed the boat because they were down at the bus station. He called the process destructive. It is not destructive from the point of view of resource sellers. It is not destructive for customers. It is destructive only for losers who did not help either resource buyers or customers.
The free market's process of enabling entrepreneurs to bring together resource sellers and product buyers should not be called creative destruction. It should be called creative production. It could also be called creative substitution. A successful entrepreneur goes to customers and makes them an offer: "Buy from me, not from my competitors. I will offer you a better deal." He can afford to offer a better deal because he bought production goods at prices lower than his rivals did.
Schumpeter borrowed the concept from a pair of revolutionists, Bakunin and Marx. They preached rival social philosophies that were both based on literal murder, not figurative murder. Schumpeter was impressed by their concept. Felix Somary records in his autobiography, The Raven of Zurich (1986), a discussion he had with the economist Joseph Schumpeter and the sociologist Max Weber in 1918. Weber was the most prestigious academic social scientist in the world when he died in 1920. Schumpeter expressed happiness regarding the Russian Revolution. The USSR would be a test case for socialism. Weber warned that this would cause untold misery. Schumpeter replied, "That may well be, but it would be a good laboratory." Weber responded, "A laboratory heaped with human corpses!" Schumpeter retorted, "Every anatomy classroom is the same thing." Weber stormed out of the room (p. 121). I don't blame him. (I am indebted to Mark Skousen for this reference.)
CONCLUSION
It is time for defenders of the free market to abandon Schumpeter's concept of the free market's creative destruction. The concept is theoretically erroneous, as Murray Rothbard pointed out in 1987. But it is also a strategic liability. The market process is destructive for entrepreneurs who guessed wrong and failed to satisfy customers. It is creative for everyone else.