Dynamic Economies Experience Creative Destruction
Dynamic economies often force inefficient firms out of the market and make way for new firms with better ideas under a process called creative destruction. On the whole, creative destruction is a healthy, organic process that helps to put resources to their most efficient and pragmatic use. But, on occasion, a little too much jubilance is expressed over the demise of an existing firm. Just as we shouldn't dance on graves, we should be wary of too much jubilance in the downfall of a firm.
Firms Are Nothing More than Groups of People
Unfortunately, the case of creative destruction can reveal in market-friendly thinkers the same false image of the firm as a nameless, faceless institution that the socialist world so often embraces. Firms are nothing more than groups of people, organized to achieve common goals. Just as it is wrong for a leftist protester to lob bricks at storefront windows while hurling epithets at imagined corporate demons of globalization, it is wrong for the defenders of rule-of-law capitalism to express glee at the failure of a business, even when that business had reason to fail.
In both cases, the outside party forgets the humanity of the firm. And in forgetting that a firm is nothing more than people, that outsider under-estimates the true social costs of what happens to that firm.
The Ultimate Costs of Business Failures Reach Beyond the Failing Firm
When a firm goes under -- even when due to the natural process of creative destruction -- the burden of suffering falls on many shoulders:
- Investors, many of whom may have had no reason to anticipate that the firm in which they had entrusted money was being rendered uncompetitive. Fraud at Enron cost investors $32 billion; while the market needed to be cleared of the corrupt behavior behind the company, those investors were largely innocent casualties.
- Employees, who (especially when low on the ladder of power and thus most vulnerable when job loss occurs) may have had no reason to expect some change in conditions outside their power to render them jobless. Tens of thousands of workers who lost jobs at Montgomery Ward and Kmart because of competition from Wal-Mart and other retailers probably had very little to do with or say about the strategic direction of their respective employers, but the pain was certainly theirs.
- Customers, who having built trust in and plans around a steady supply of goods or services, are rendered powerless in the face of change. The failure of WorldCom put millions of dollars' worth of communications contracts in jeopardy, disrupting the ordinary work that those customers intended to do via the existing service and forcing them to spend their own resources on seeking out and considering alternatives.
- Suppliers, representatives, and other creditors, who, being good at some other business, had little or no reason to closely track changes in a different industry. These are perhaps the least-recognized victims of business failures, but they are often the hardest hit. While Boeing's credit rating survived United Airlines's Chapter 11 filing, but imagine the position that smaller firms are put in upon receiving notices from the airline reading, "At this time, the company by law cannot pay for goods and services received before the filing. Payment for these pre-petition invoices will be determined by the Bankruptcy Court at a later time." To a relatively small firm focusing on its core business rather than on the airline industry, such blows can be fatal.
What Should Be Done: Not Government Action, But Better Management
Pre-emptive government action really isn't the solution to stanching the blood losses of creative destruction. Most protective government action has perverse consequences and distorts the market in ugly ways. While there are some after-the-fact cushions that government may be able to offer (unemployment insurance and job re-training, for instance), it would be similarly (and unhappily) market-distorting for government to offer insurance to all possible stakeholder in a failed firm.
The burden actually falls most squarely on the shoulders of business managers themselves. Business management requires vision and foresight, and part of the inherent moral obligation to running a firm is the imperative to let creative destruction take its course in forcing the business to adapt and change without causing it to fail outright. To the extent that golden parachutes and lax ethics impair the judgment of business managers to see and respond to those changes ahead, they act just like intoxicants that keep a driver from following a curve in the road without landing in a ditch.
Bottom Line: To Preserve Free Markets, Consider the Broader Picture
The market economy is the single most powerful tool for human development and freedom, bar none, and the process of creative destruction -- of re-allocating resources from inefficient to more efficient uses -- is a vital component of the market. But our enthusiasm for the swift and efficient workings of the market should be tempered with a reasonable understanding of the "total cost of ownership." While creative destruction may be vital, it can also be terribly painful. Worse, it can have the effect of turning friends of the market into enemies if they are themselves hurt too much or too often.
Rather than taking abstract delight in the failure of firms that somehow missed the mark, market enthusiasts should adopt a sober view of the process and seek ways in which creative destruction can be contained within firms, rather than causing their outright collapse. There is no iron law dictating that a market can only change when its component firms die; instead, an open-eyed view of market change would suggest that business failures have a larger social cost than we readily acknowledge on the balance sheet, and that there is in fact a moral imperative on the shoulders of managers and business owners to intelligently change with the times -- especially lest they contribute to the erosion of popular support for the greater cause of market economics. To the extent that careless business dealings, golden parachutes, and outright hubris get in the way of that moral imperative, market enthusiasts should in fact be the most self-critical of all.