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A Bright Future for Destruction


Written on 13 September 2011 by Kris Sayce

A Bright Future for Destruction

What drives progress?

The answer is simple. And it probably won’t surprise you.

But it’s hard to focus on progress when all you see is regression.

The Financial Times headlines, “Italy turns to China for help in debt crisis”.

The Age says, “Retailing to go from ‘bad to worse’”.

And Bloomberg News reveals, “BofA [Bank of America] to Slash 30,000 Jobs in Cost-Cutting Plan”.

Every way you look, you see destruction… job cuts, companies going bust and countries borrowing and begging from other countries.

Things look bad. And if we’re honest… it is bad.

But among the gloom, there’s something to look forward to.

It’s this…

No progress without destruction

Progress needs destruction. We know that may sound weird, but it’s true. Throughout history all improvements to human life have come as a result of destruction.

We’re talking about entrepreneurs coming up with new ideas, products and services that replace existing ways of doing things.

It’s destruction caused by creation.

In this case it’s where the destruction hits an established business. Now, the business isn’t necessarily doing something bad. It’s just that entrepreneurs always look for ways to make a profit.

If there’s no way for new firms to make a profit with an established product, an entrepreneur will find a way with another product.

The technology sector is a perfect example.

When new technology is introduced it will typically have high profit margins. This is because it’s new and the firm has invested a lot of money in it. So, in order to make money the firm charges a high price.

It’s a risk, because there’s no guarantee consumers will pay the high price. But if they do, the technology firm is on a winner… and the profits start racking up.

But there is a downside for technology leaders. High profits act as a signal to competitors. This causes competing firms to enter the market to get a cut of the action.

And because the established and new firms want to gain market share (and profits), the inevitable result is a race to the bottom as they undercut each other… prices and profits are slashed. This is, of course, great news for the consumer.

And it’s good news for progress and creative destruction too.

Why?

Searching for profits

Because at some point it becomes unattractive for new players to enter the market. Start-up costs and low profit potential means entrepreneurs will look elsewhere. Simply put, the “high profit signal” isn’t flashing anymore.

But that doesn’t mean progress stops. Entrepreneurs will just look for other ways to make money. And so the search for profits leads entrepreneurs to come up with newer ideas… something else that could shake up the same or a different industry.

Take television manufacturing as an example. The last 10 years has seen the industry go through several phases: old style CRT… rear projection… plasma… LCD… LED LCD… 3-D LED LCD… Smart 3-D LED LCD… what comes next?

For all we know, the “next” may have already happened but we haven’t seen it yet!

As each technology appears you see a wave effect in prices. Plasma TV prices were high until LCD TVs came on the scene… then they dropped. But as soon as LED LCD TVs appeared, standard LCD prices fell too… LED had become the new premium product.

We use this example because it’s the most obvious and visible. But this is what happens all the time. And not just in the technology sector. It happens with any industry.

But in order for progress to advance, you need an environment where entrepreneurs can flourish. Without it progress stops.

For years, Western governments have meddled with the free market. Erecting barriers to entry to keep entrepreneurs from destroying established businesses with new innovations.

That doesn’t mean entrepreneurialism is dead. It’s just harder to find.

But maybe it won’t be that way for long.

Looking forward to the future

A positive from the disaster happening in Europe and North America is the experiment of allowing governments to steer national economies is proving more of a failure as each day passes.

The destruction of national economies in Europe is painful. But the upside is it’s purging economies of welfare dependency and that should result in smaller governments.

And that’s why, in the long run we’re positive about the future.

The reversion to smaller governments will allow an altogether more positive type of destruction to take hold – creative destruction.

Old ways of doing things – ways created by the State – will be cast aside and replaced by the next breed of entrepreneur. One who can make profits without fear of government taxing away their gains.

This won’t happen overnight. But ultimately, we’ve greater faith in the abilities of entrepreneurs than we’ll ever have in the abilities of meddling bureaucrats.

Cheers.
Kris



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Kris Sayce
Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the investment director for Australian Small-Cap Investigator, Diggers and Drillers and Revolutionary Tech Investor. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays. Read more about Publisher and Investment Director Kris Sayce.

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17 Comments For This Post

  1. Janet Says:

    All very convincing…but…all this product innovation and company development relies on… the end consumer being able to afford to buy what-ever-it-is. Given the cummulative debt load carried forward from the purchasing of the last many innovations, I’m not sure there is the fire power left in the Western consumer to adopt….well…anything new that arrives!

  2. M&M Says:

    Janet – I agree.

    When will debt be low enough to encourage spend / new borrowing to fuel demand. If not a when, then what debt to home equity or debt to GDP will people’s sentiment change and encourage private spending/borrowing?

    This decade I hope!

  3. SG Says:

    The popular media is pushing China to the rescue………but they also had this to say

    “Italian Economy Minister Giulio Tremonti said on Thursday that Asian investors are reluctant to buy Italian bonds because it sees they are not being bought by the European Central Bank.”
    From Reuters “Italy says Asia asking why why ECB isn’t buying bonds”:
    And;
    When you talk to Asia they say: “We don’t understand what Europe is,” he continued. “The second point is that they say ‘if your central bank doesn’t buy your bonds, why should we buy them”?
    So I see a reluctant lender that will not keep it up……will these dead beats end up out of the Euro and with their own personal central bank to do the buy?

  4. J.C. Says:

    Janet@1,
    Sayce gives one example. There are also innovative business models for the indebted and depressed. The Japaneae have already cornered the mfng/retail model for low-cost FMCG. The West is at least 10 years behind and the Japanese have cornered the quality supply chains.

  5. Drood Says:

    For all you free marketeers,

    Somalia currently is the only country with a free market and almost no government, a role model for the Sayce ideal.

    As a result of inadequate government support and administration, Somalia’s private sector has grown considerably, particularly in the spheres of trade, commerce and infrastructure. Private participants have also extended their contribution to the primary sectors, particularly in livestock and fisheries.

    excellent say the free market gurus, just as we said it would, but.

    The United Nations, in a 2007 report, stated that Somalia’s service industry is thriving. Despite these favorable changes, Somalia has a meager GDP per capita of $600.

    So what is the free market doing for the Somali people….zilch

    So how do we help the Somali,s is there any hope for them ?

    The absence of a central government authority has been detrimental to Somalia’s economy, particularly to its currency, which has been debased considerably. The Somali Shilling exchange rate reached a historic low of 30,000 per US dollar in 2002. Absence of adequate government intervention was also responsible for the fake currency racket, which escalated in 2007, pushing up Somalia’s inflation rate significantly. Manufacturing has ceased to be a significant contributor to Somalia’s economic structure due to inefficiencies in the sector.

    so much for the free market.

    Despite facing extreme poverty, Somalia fares better than several African nations in terms of economic potential and infrastructure. What the nation needs is a stable and able government that is able to capitalize on its economic potential.

  6. J.C. Says:

    Drood, how is that relevant to Schumpeter’s creative destruction? But I guess you’re right. Most people would rather kneel down before a govt to solve its problems (at the expense of others) rather than live free. It’s a natural response but I doubt you will fund the comfort you seek.

  7. The Wolf Says:

    Drood has an unnatural and unnerving interest in Somalia…my guess is he has lost several thousand dollars to a “princess” who turned out to be a 39yr old conman called Igbu…

    :-0

    For the defenders of Keynes…and fiat money…

    http://www.zerohedge.com/news/median-male-worker-makes-less-now-43-years-ago

  8. KP Says:

    haha Drood- the other side of your coin is Zimbabwe, that rich thriving country completely under Govt rule…

    So, which would YOU prefer, Zim where they can’t use their own currency, Govt corruption with break you or kill you, and there is nothing to buy in the shops? or Somalia, where you need the protection of your local Police (sorry, warlord) and you live like any other African in the third world.

    Actually, the longer whites ruled an African country the better it is today, so South Africa is the most advanced.

  9. Drood Says:

    I have yet to see one single argument from you losers to support how a free market would work in reality. You cant continually whine about the status quo without suggesting a credible alternative, its like saying “we need a spaceship to go to mars” without knowing how to build one.

    JC…. You can live free anytime you like, but you have no idea how. I have done it and found it has good and bad points, but at least i had the balls to try. You just want someone to do it for you.

    KP….. that just shows you to be an ignorant racist.

    Wolf…..close but his name wasn,t igbu

  10. SG Says:

    You’re not here to read others arguments or to really listen to someone else’s response your here to be angry
    Why not focus that energy in one of these countries and actually help instead of spending this energy tormenting others with your frustrations

  11. Drood Says:

    SG…….very enlightening

  12. Bobby Says:

    It does seem that people have ventured off the main ideas in the article. There is some truth in the progress needs destruction in technical terms where old machinery and processing systems are replaced with new and people are retrained in new tools and achieve better results with new technology. However at the moment we are seeing the good old classic gunboat diplomacy in Africa and the Arab world (to replicate the success of the East European Spring in the late 80′s). This “liberation” drive will open up the area to western products in order to offset their oil exports. Democracy will be delivered with capitalism whether they like it or not.

  13. The Wolf Says:

    Well worth a look

    http://www.zerohedge.com/news/jefferies-describes-endgame-europe-finished

  14. shaun Says:

    Wow I see this site is really just for the bears, the suckers who wait and wait until everything is stable and looking dandy.. THEN, put all your money in the market. Short this, destruction that, sell, sell.. Can see a theme running here.. the world will come to an end, but definitely not while retail investors are in on the game.

  15. Chris Chalkley Says:

    This article ha a great start, but it took quite a leap to go from Creative Destruction to smaller governments. Ironic that a site that encourages buying gold and discourages borrowing to buy real estate would cheer the progress of Creative Destruction. If ever there was a product of ‘the old ways’ it is the value of gold. Yes we are in a gold bubble now, but it won’t last. Gold was an important permanent store of wealth in ancient agricultural economies. It still is in today’s third world economies. Gold has lost 95% of its value since the middle of the Industrial revolution. As an example, in the 1850s Melbourne had its first land sales. A block of land in what is today’s CBD cost five shillings, or about 3 ounces of sterling silver (a quarter of a Troy pound sterling), or about one third of an ounce of gold. Anyone who decided to keep gold and wait for the property collapse would now be able to afford a few weeks’ car parking in the CBD. The fiat currency hasn’t been so bad.

  16. Hans-Dieter von Senff Says:

    Laugh, if you want to, but communism could be just around the corner.

    In the 2008 Global financial crisis, caused by the United States of America, remember it was caused by Banks who got too greedy. These Banks were bailed out by the public purse, who assumed the debts run up by the private sector. The Private sector was given new money to proceed with the same
    nonsense, while the governments assumed the debts and the Taxpayer got the rough end of the pineapple.

    Assume for a second, that businesses in the near future, and it has happened before, can no longer make profits. Witout profit, workers, hence the Taxpayers get sacked, while the Government scratches around in order to raise the money to pay for the public debt it so willingly has assumed to bail out private investors in all kind of businesses. So, back to the printing presses to print the trillions of U.S. Dollars to pay the public debt…

    But, it is not only the United States, this time it will be the whole capitalist world that will be affected, markets will be protected by necessity,to hell with the level playing field, domoinated by a few countries who rely on exports, trade wars will start again in order to protect their markets. while the ordinary Tax payer, if he is still employed, will have to fork out more and more to subsidise the economic criminals who caused this in the first place. How long does one wait to the hip pocked nerve to react, before a Taxpayer notices, that he is being fleeced for the private sector by the government.
    A government that is seen to wage economic warfare against its own people will wait not long, before it is overthrown. Not by the ballot box, oh no, but by the anger and need of its own people to get rid of the representatives of private enterprise. How long, before a people will demand from the private sector, to return the money so freely given, to those, to whom it belongs.

    Remember, without profit private enterprise ceases to exist and government enterprises will be forced to fill the void. No private enterprise without profit.

  17. JONATHAN URLICH Says:

    Hans-Dieter what planet do you live on? Communism failed in the old USSR and has only survived in China by adopting Capitalism! Capitalism is the only path to prosperity. It is the great enabler for humanity!

    The fact is that the credit crisis was caused by Governments and some of their citizens borrowing too much money! That was their fault and not the fault of the Banks.

    This was all promoted by Socialists like Bill Clinton when he relaxed the lending criteria around the US housing sector. If you want to blame anyone then direct the blame to the people who borrowed too much.

    We are now entering the period of the Great De-leveraging. capitalism will survive this as it always has in the past. I do not no if Socialism will survive it. I suspect the Socialists will be swept aside by the Conservatives who have some idea how to Govern in these situations.

    There will be winners and losers. Those of us who understand what is happening will make money and sadly others will have less.That is the way things work in the real world.



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