Creative Destruction: Why Entrepreneurship Booms During Economic Crisis

Gusto Editors

As odd as it may sound, there are silver linings during times of mass layoffs, economic disparity, and instability. When you hear the term “economic crisis,” you’re probably not thinking about new beginnings, new opportunities, and new growth. However, if you look under the surface, that’s exactly what you’ll find. 

To help you see the opportunities hidden within challenging times, we brought you another episode of On the Margins: LIVE, with hosts Caleb Newquist, Gusto’s Editor-at-Large, and Will Lopez, head of Gusto’s accountant community. The duo discussed a phenomenon called “creative destruction,” how it helps first-time entrepreneurs, and how it leads to new business formation.

What is creative destruction in economics?

America has always been a wild place where the risk is high, rewards are great, and economic circumstances are always changing. Our dynamic economy is propelled through booms and busts, ebbs and flows, which result in the shaping and reshaping of industries. Economists call this phenomenon “creative destruction,” and it is an essential component of capitalism

When the new rapidly replaces the old, times of great loss inevitably lead to great growth. One example of this cyclical phenomenon is that of the COVID-19 Pandemic. 

The global health crisis, worldwide shutdown, and mass layoffs left people at home with more free time than they’d ever had before. Many lost jobs permanently, but in this destruction and chaos were the seeds of new beginnings. In the third quarter of 2020, the US Census Bureau—in partnership with the Federal Reserve, the University of Maryland, and the University of Notre Dame—saw the highest number of new business applications since they started tracking them in 2014. At 1.5 million applications, this was no small number.

Furthermore, nearly half a million new business applications were filed in January 2021. More than 100,000 were in the retail industry alone, which included a significant e-commerce boom. Data from the Wall Street Journal supports these numbers, as they reported that one million of Shopify’s new customers are first-time entrepreneurs.

Colleagues having a discussion in the board room.

This is the silver lining. More than ever, people have the opportunity to fill the void by going after their long-held or perhaps newly generated dreams. They have the chance to break free from the 9-to-5 work schedule, recreate and reshape their industries, and find new ways of living and working. These opportunities haven’t been happening in spite of loss—they’ve been happening because of it. 

“A lot of this new business creation has been the result of a lot of business failure. While the total number of businesses that closed in 2020 is still unknown, Yelp estimated that between April and September of [2020], over 160,000 businesses had closed. UC Santa Cruz estimates it’s even higher than that [at] over 300,000 between February and September.”

– Caleb Newquist

Of course, the downside of all of this is that in order for there to be a void to fill, there will need to be a loss. This means big spikes in unemployment, which can have serious consequences in a country without safety nets such as affordable healthcare, adequate housing, and unemployment benefits for everyone. It’s important to note that “creative destruction” is a uniquely American process. High peaks and low dips are inherent to our economy and social structure, as opposed to a more steady, stable, yet less dynamic flow in places like Western Europe.

“Countries like Germany have a slightly different approach. They have something called Kurzarbeit, which helps businesses pay their workers in order to keep those workers employed. The program helped keep Germany’s unemployment rate low throughout the pandemic, [at] just over 4%, whereas the US had spiked to over 14%.”

– Caleb Newquist

Kurzarbeit bears similarities to an emergency loan that was put in place during the Pandemic, the Paycheck Protection Program.

“The Paycheck Protection Program that came out of the CARES Act was designed to do something similar. It helped small business employers keep their employees on payroll. PPP is kind of like a diet version of Kurzarbeit. In other words, you’re getting a slightly crappier tasting Kurzarbeit. The PPP is a temporary program, but you get it without all the calories, so taxpayer funds aren’t constantly going to businesses that should probably just fail.”

– Caleb Newquist

Caleb made an important point—while having more consistent and comprehensive social security programs makes Germany more stable, it leaves less room for innovation. Without a loss of businesses, there isn’t room for newer, more progressive ones to sprout. On the other hand, do we really need so many new businesses? Starting a business and running a successful business are obviously two very different things.

The risk of entrepreneurship

Women entrepreneurs discussing work in office.

Being an entrepreneur isn’t for the faint of heart. There are long hours, tough calls, and no guarantees. Many, if not most, businesses will fail within a few years. So a flourishing of new ventures that begin during dark economic times doesn’t necessarily lead to an economic renaissance.

“Starting a business can be an exciting and rewarding adventure, and it can contribute to a lot of economic activity, … but should everyone start a business? The answer is probably not. It takes a lot of time and hard work and luck to make a successful business, and if you don’t have the right idea at the right place and the right time, your business might be doomed before it even starts.”

– Caleb Newquist

To make his point, Caleb shared an example of a woman who started a recycled hat business on Etsy during the shutdowns. Is that a business that will prosper in years to come? Not necessarily. He pointed out that people started new ventures out of necessity, to find creative solutions to challenges, supplement income, and survive lean times.

Even those who have grand ideas or who always wanted to start a business may realize that they’re not getting enough of a return on their investment of money, time, and energy. He expects to see a large percentage of people returning to working for someone else at a regular job.

There’s more to the story than just the potential for failure. Launching a new business has always been tricky, especially in the United States, for one important reason: the lack of a safety net. Unemployment hasn’t historically been provided for the self-employed or entrepreneurs. Healthcare is a for-profit system that’s tied to employment, and medical costs in the States are devastatingly high. Entrepreneurs have to fend for themselves in these areas by finding adequate insurance, doing all of their own accounting and bookkeeping, and putting aside a safety net should they meet hard times.

“The risk of entrepreneurship is getting your own health insurance [and] making sure you’re making enough money to live on. … [That’s the] trade-off. So you have this high-risk-high-reward [scenario].”

Caleb Newquist

With this many new entrepreneurs learning the ropes, the need for advisors is greater than ever. Small businesses and entrepreneurs need someone who can do more than just balance their books and prepare their taxes. They need sound financial acumen and a holistic view of their businesses, including when to hire or scale and when to hold back. In providing these valuable services for them, advisors can help them avoid costly mistakes that may shut them down.

At the end of the day, being an entrepreneur will not be for everyone. But for those who can make it, they will have a period of loss to thank for their new creations. That’s their silver lining.

Learn more about creative destruction

Creative destruction is a term economists use to describe the boom-and-bust nature of the American, capitalist economy. The theory holds that times of economic loss, instability, and destruction will inevitably lead to progress, innovation, new businesses, and new ways of operating. This dynamic yet unstable process has considerable risk and inherent loss. 

Unlike Western Europe, the United States has little in the way of safety and support for the unemployed or uninsured. This makes being an entrepreneur risky. And since many small businesses fail, it’s clear that entrepreneurship isn’t for everyone. 

At the same time, those with bold visions, good timing, and grit wouldn’t have gotten their chance if there hadn’t been an economic fallout to begin with. As people navigate economic loss and try to get their heads above water, the need for trusted advisors is greater than ever.

Gusto is here to help you make the most of every opportunity. There is so much more to learn about challenge, growth, and entrepreneurship, so check out our other article based on the same episode: “The Rise of Entrepreneurship: Turning Problems into Innovations.”

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Gusto Editors Gusto Editors, contributing authors on Gusto, provide actionable tips and expert advice on HR and payroll for successful business management.
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