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Was, and is, the COVID-19 crisis a creative destruction process?

12/01/2021

Answer by Andrea Grisold, head of the Institute for Heterodox Economics

Maximilan K.: War und ist die Covid-19 Krise wie Schumpeter es einmal gesagt hat ein Prozess der kreativen Zerstörung?

Answer by Andrea Grisold, head of the Institute for Heterodox Economics

As we have feared, we can be fairly certain that the COVID-19 measures will result in a serious economic crisis. This begs the question of whether there are any positive aspects to be found in this situation. Unless, of course, you’re like the German author Erich Kästner, who was asked, “But what about the good things, Mr. Kästner?” to which he replied, “No idea where the hell they’ve gotten to.”

Joseph Schumpeter (1883–1950) first introduced the term “creative destruction” in his book “Capitalism, Socialism and Democracy,” published in 1942. And to this day, the concept is still inseparably linked with his name and work, even if the term itself was “borrowed” from the German economist Werner Sombart.
Schumpeter understood this to mean that dynamic ‘entrepreneurs’ push ahead with innovations that spark off economic development processes, resulting in the creation of new and better things. For this to happen, the old ways have to go, and are destroyed. This reconstructive process generates long-term growth, but this growth is the result of economic fluctuations and structural adjustment processes. So essentially, dynamic chaos encourages the further development of economies. According to Schumpeter, these dynamics are key to the development of capitalist economic systems.

His 1942 bestseller “Capitalism, Socialism and Democracy” included a surprising twist, however, as Schumpeter considered the development from competitive capitalism to complex conglomerates to be the first step towards socialism, as control over the means of production would be handed over to a central authority made up of managers involved in planning.

As often seen in Schumpeter's work, it is these very special ‘entrepreneurs’ who creatively and imaginatively seek out innovation and have the skills to bring it to life. Schumpeter’s obsession with exaggerated entrepreneurial personalities as “driven” and “heroes” was viewed critically from different sides at the time and still is today. And with good reason: We know today, not least through the pioneering work of Mariana Mazzucato, that many of the technological breakthroughs often attributed to romanticized versions of individual developers working out of a Silicon Valley garage are actually the result of government investment programs (and by no means solely for military purposes – the health care sector is a good example).

But back to Schumpeter: He saw himself mainly as a “developmental theorist,” and strove to explain the secret behind revolutionary and disruptive change: “… such changes in economic life as are not forced upon it from without but arise by its own initiative, from within” (Schumpeter, Depressions. In: The Economics of the Recovery Program, 1934, p. 63). And this is a crucial point, but one which is not (or not yet, anyway) relevant in the context of the current COVID-19 crisis: The current crisis is not the result of inherently economic developments, but is rather an external force affecting the economy from without. This means it is not a creative destruction process as described by Schumpeter.

According to Schumpeter, it is organizations that continue to develop and change that guarantee stability. Currently, the opposite is the case: Much of our economy is paralyzed with shock, an effect that is observable during and after other types of crises as well.

For example, we know from studies that confirm the positive function of creative destruction that restructuring typically declines during recessions (Caballero and Hammour, The Cost of Recessions Revisited: A Reverse-Liquidationist View, The Review of Economic Studies 72/2, 2005), meaning that there is little creative destruction going on in times of crisis. From this perspective, it is especially important to view both the recession and the subsequent recovery process as a single entity, but it is certainly too soon for that at this point.

In summary, the short answer to the question posed above is: For the most part, no, and only to a very limited extent yes.

This crisis is not like previous crises in that it is not endogenous, i.e. a product of the economy itself. It is not the result of an industry with out-of-date production methods, or a financial crisis that caused the economy to shrink. In this case, the unprecedented standstill of large parts of the economy – caused by an extraordinary risk to public health – will take a long time to slowly resolve itself.

The destruction of companies, assets, products, and careers is often the price of progress. This is how Joseph Schumpeter describes “creative destruction.” Currently, however, the causality is turned around: We are observing the destruction of companies and whole sectors, but given the present situation, it does not seem likely that this will result in a burst of innovation. That being said, some restructuring processes – those already set in motion before the COVID-19 crisis – will probably strengthen, for example digitalization. How, exactly, and to what extent? There is no way to accurately predict that at this point.

For now, let’s just reflect on what makes Schumpeter’s work so worth reading, even today: the precise analytical ability to recognize the limits of what we can predict. All the answers given here can be no more than an educated guess; after all, our modern economies have never been faced with a situation like this before.

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