“Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary.”
- Austrian Economist Joseph Schumpeter (1950)
A couple of weeks ago, the 2025 Nobel Prize in Economics was awarded to Joel Mokyr, an economic historian at Northwestern University, Philippe Aghion, who is affiliated with universities in France and the U.K., and Peter Howitt, a professor of economics at Brown University.
The three of them didn’t work together, but Philippe Aghion and Peter Howitt did. They developed a model that made it possible to understand innovation-driven growth, the kind that makes not just winners, but losers as well.
What is Creative Destruction?
Creative destruction theory was first used by economist Joseph Schumpeter in 1942 to describe how innovation dismantles established economic structures to make way for new ones. He described it as the, "process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one."
This theory accepts (and even encourages) the idea that competition will lead to some companies failing. It prioritizes a long-term over short-term perspective on growth, and it runs in contrast to economic theories that aim to achieve equilibrium, even in the process of growth and innovation – more like the idea of supply and demand eventually meeting in the middle.
Aghion and Howitt won the award for their study and modeling of innovation and its effects on existing markets, but it is important to draw a line between innovation and invention.
As Kate Vitasek (Vested) wrote in a piece for Forbes, “What differentiates creative destruction from other ideas of ‘invention’ is that is fueled by business leaders.” Those leaders are in a position to take a product or service to market, compared to a tinkerer who can invent the best thing ever but doesn’t necessarily have the ability (or interest) to bring it to market and scale.
Feel the Churn
One of the benefits that we get from the Nobel Prize winning model is the ability to see that while everything may look stable on the surface, in the details, nothing is.
Small gains and losses cancel each other out, but they are still part of the creative cycle. This means we are already – and always – living in the midst of Creative Destruction, we may just not realize it.
While the model for Creative Destruction may not be fully stable, according to Aghion and Howitt, it can achieve general equilibrium. Bringing multiple markets into one economic model, such as household spending and research and development spending, makes it possible to reach equilibrium without achieving stability.
In the United States, 10 percent of businesses go bankrupt each year. Creative Destruction presumes that the ones that went bankrupt weren’t viable and that the ones that start up have a better chance of becoming profitable.
This dynamic provides an incentive for companies to invest in R&D, to get to the top of the pile… and to increase their profitability. In fact, Creative Destruction can be seen as a way to innovate away from competitive pressure, or, as the Financial Times put it, “innovators are motivated by the possibility of lucrative monopoly.”
Here’s a really interesting fact: according to the Competitive Enterprise Institute, “The unemployment rate in 1776’s agricultural economy wasn’t that different from our modern high-tech economy. But the living standards have increased at least 30-fold. It’s not the number of jobs that matters for living standards, so much as what value those jobs create.”
There are two dynamics described in the Nobel Prize-winning work:
First dynamic: All technology still has value, because next-generation products can be built on top of old technology.
Second dynamic: A company that manages to displace an older, established company can charge more for their product because it is new.
With many examples of both dynamics playing out all the time, it is easy to see how business conditions might look stable from a distance, but be quite disrupted when studied up close.
Is AI Creatively Destructive?
In Schumpeter’s book, Capitalism, Socialism, and Democracy, he explains that the results of creative destruction can be best seen over time. Every moment in business is built on the solutions that went away, but each new innovation will ultimately give way to the solutions yet to come.
These ideas really stand out when they are overlaid on the effects we are seeing from AI. We are watching everything morph, right in front of our eyes, and there is no way to tell how 2025 will look in the rear-view mirror.
Jobs are going away, companies and segments of industries may follow. The question is how we help the people affected by this upheaval adjust, and how good of a job we manage to do harnessing the creativity – because we are definitely feeling the destruction.
