Creative Production

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.

Current Prices on popular forms of Silver Bullion

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.

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