WHAT IS 'Destructive Creation'

Destructive creation refers to circumstances in which innovation results in more damage to the economy than beneficial outcomes. Destructive creation was coined as a play on Joseph Schumpeter's famous term creative destruction, which suggests that innovation leads to productive changes in economic growth.

BREAKING DOWN 'Destructive Creation'

Destructive creation is a term used to describe when financial innovations become more destructive than productive. The concept is derived from the idea of “creative destruction,” which asserts that the process of industrial innovation revolutionizes economic structures from within. Creative destruction refers to the way newer innovations destroy older economic structures while simultaneously creating new ones. 

Financial innovation is a different animal than other types of innovation, and when financial innovation results in more harm than good, it is considered destructive creation.

For example, when computers were invented, they replaced typewriters and increased efficiency As a result, the economy profited. In other words, there was little downside to this innovation. However, some financial innovations are considered to be more destructive than productive. Some types of derivatives, structured investment products and non-conventional mortgages have all fallen under public scrutiny in recent years as innovations that prove to bring more harm than good. The term destructive creation was popularized during the financial crisis of 2007-2009, when large banks and insurance companies ceased to exist as a result of financial innovations such as derivatives and non-conventional mortgages.

Derivatives are financial securities whose values rely on underlying assets. A derivative is a contract between two or more parties based upon the asset or assets, and its price is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. 

Considerations of Destructive Creation

Other examples of destructive creation include the development of tools, utilities and equipment that may solve problems for consumers, and make people’s lives easier, but also take a toll on the environment. 

To avoid destructive creation, economists emphasize the importance of measuring the impact of innovation. This assessment should not only evaluate the needs of consumers, but also how well the impact is sustained through the entire life cycle of a product. Otherwise, the impact created by the solution to address a problem for one target customer group, such as low-cost cars for middle class families, could lead to the creation of new problems, such as lack of parking space, increased traffic and pollution.

When developing new products or financial strategies, examining resource allocation in a way that ensures all stakeholders in a society benefit can curtail destructive creation.

 

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