How creative destruction works (and is working in Las Vegas)

Victor Joecks

Creative destruction is an essential part of the free market. Economist Joseph A. Schumpeter coined the term in “Capitalism, Socialism and Democracy.”

Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary. …

As we have seen in the preceding chapter, the contents of the laborer’s budget, say from 1760 to 1940, did not simply grow on unchanging lines but they underwent a process of qualitative change. Similarly, the history of the productive apparatus of a typical farm, from the beginnings of the rationalization of crop rotation, plowing and fattening to the mechanized thing of today-linking up with elevators and railroads-is a history of revolutions. So is the history of the productive apparatus of the iron and steel industry from the charcoal furnace to our own type of furnace, or the history of the apparatus of power production from the overshot water wheel to the modern power plant, or the history of transportation from the mailcoach to the airplane. The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation-if I may use that biological term-that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and what every capitalist concern has got to live in. [Emphasis added]

In my own words, “creative destruction” means this: Because there are limited resources in the world (scarcity), in order for there to be innovations and improvements there must also be a destruction and redistribution (through private decisions) of the scarce resources (raw materials and employees, etc.) that were being consumed by less productive means.

This is why it’s so important that bad businesses are allowed to fail and lose money (as happens naturally in the marketplace outside of government interference). If bad businesses aren’t allowed to fail, the limited resources that they are using will be stuck in inefficient and unwanted businesses instead of becoming available for better uses (as determined by the individuals in the marketplace). And if the government doesn’t allow bad businesses to fail, successful businesses and taxpayers will be forced to subsidize them – literally rewarding failure.

Anyway, that’s a long way of saying that there’s a great story today in the Las Vegas Sun about how the recession is creating new opportunities for businesses – creative destruction in action.

Even as many retailers and food establishments are struggling to outlast the recession, franchises and chains are entering the market or expanding their footholds.

Some are taking advantage of the sharp decline in rent, the availability of storefronts at high-traffic shopping centers and declining competition. …

“We are doing this for the long term,” said Loren Kreiss, spokesman for San Diego-based Kreiss furnishings, which in July at Town Square opened its 14th U.S. store. “We see the benefits when others are shying away. It is an opportunity for us to get in the market. Our strategy is to double down where we see the growth.” …

The recession does have its benefits: [Business owner Todd] Miller says his rent is about a third of what was charged several years ago.

Recessions are a normal part of the business cycle (especially, as F.A. Hayek and my colleague Geoffrey Lawrence have argued, since the Fed inflates the money supply) and must be allowed to run their course.

If recessions are a normal part of the business cycle, why has this one lasted so long? Because it hasn’t been allowed to run its course. From bailouts, to the stimulus, to Government Motors, to propping up Fannie and Freddie, to imposing huge new health care mandates, to the looming expiration of the Bush tax cuts, the federal government has been trying to save failing businesses for the last two years – hindering the creative destruction of the market.

And it’s failed miserably.

The government’s been trying to prop up failing businesses, and this has led to a failing economy. Government needs to get out of the way. Bad businesses need to fail so that new businesses can attempt to use the scarce resources, which were previously tied up in the bad businesses, in more productive ways.

As Las Vegas shows, creative destruction works – if it’s given a full chance.