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Entrepreneurs' Evangelist

Joseph Schumpeter laid bare the pros and cons of "creative desctruction"

July-August 2007

Thomas McCraw, Straus professor of business history emeritus at Harvard Business School, has written a large book about a Harvard professor of economics who was a legend in his own time and is possibly a bigger legend now, more than half a century later. Joseph Schumpeter taught at Harvard from the 1930s to 1950, after a tumultuous life in eastern Europe. He wrote two books that have become classics—and that are accessible to ordinary people: in other words, to non-economists. The first, written initially in the flush of optimism preceding World War I, is The Theory of Economic Development. The second, written in the dark days of World War II, is Capitalism, Socialism, and Democracy. The books, which deal with entrepreneurship and “creative destruction” in economic growth, respectively, have taken their place over the years alongside similarly influential and popular works by John Maynard Keynes and John Kenneth Galbraith. I recommend both volumes, as well as this graceful biography of their author.

Thomas K. McCraw, Prophet of Innovation: Joseph Schumpeter and Creative Destruction (Belknap/ Harvard, $35.)

The first half of McCraw’s book treats Schumpeter’s life before Harvard. He was born in 1883 in a small Austrian town, where his childhood was disrupted by the untimely death of his father. To simplify a complex story, his mother moved to Vien-na, married again, advantageously, and obtained a superior education for her gifted son. The young man respond- ed to this upbringing by taking on the persona of Victorian minor nobility. He started his academic life while trying unsuccessful careers in both politics and business in the chaotic conditions of postwar Austria. In a famous boast recorded by McCraw, Schumpeter said he aspired to become the greatest economist, horseman, and lover in the world, but that he was having trouble with the horses.

The second half of the book chronicles Schumpeter’s life at Harvard. The legend quickly became a prima donna, ignoring and antagonizing his colleagues in the economics department. But when Yale offered him a job, Harvard responded with warmth. His students, including several future Nobel laureates, implored him to stay—and he did. Plus a change… His large book of the interwar years, Business Cycles, was eclipsed by Keynes’s revolutionary book on the same topic, and Schumpeter resisted the resulting Keynesian revolution in economics. Meanwhile, his former mistress wrote him about deteriorating conditions in eastern Europe in the late 1930s. McCraw presents excerpts that make a grim contrast to the far safer conflicts at Harvard, ending with a letter informing Schumpeter about her murder by Nazis in 1942.

Schumpeter’s second great book, published that same year, presents his distillation of economics, history, philosophy, and social thought at this critical time in world history. While The Theory of Economic Development is hopeful, Capitalism, Socialism, and Democracy distills the uncertainty of the 30 years that followed the earlier work, including two world wars and a great depression. It is a far more complex book, and it is read—and still repays reading—more often than most classics. McCraw provides comprehensive views of both books.

The Theory of Economic Development was originally published in 1911; the revised English edition appeared in 1934. Its central thesis is based on a distinction between static efficiency and dynamic progress, an issue that is as live today as it was then. Schumpeter started with a typical nineteenth-century description of the static circular flow of money and goods that can be found in only slightly different forms in many recent economics textbooks. He then argued that the key to economic development was composed of actions by entrepreneurs that deviated from this static circular flow and introduced new products or processes. He argued that innovation required effort and, of course, ingenuity, which needed to earn profits to be stimulated. Clearly, the ideal of perfect competition—in which all profits larger than the cost of capital are swiftly competed away—was not suitable for economic development. There needed to be some market power stemming from the entrepreneurial activity. (Schumpeter’s concern with economic progress is in tune with contemporary economic research; Robert E. Lucas, the 1995 Nobel laureate in economics, has said that once you start thinking about the growth of productivity, it is hard to think of anything else.)

In this book, Schumpeter anticipated his later position by acknowledging that any monopoly to an innovation would be competed away in time. In Capitalism, Socialism and Democracy, his greatest work, he took this hypothesis further, introducing the term “creative destruction”—something McCraw emphasizes throughout his narrative. Every innovation is both an act of creation and an act of destruction of someone else’s enterprise and profit. As Schumpeter noted in his earlier book, “Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary.”

And this is the problem. According to Schumpeter, as this ceaseless process of change goes on, it carries the seeds of its own destruction. The process of creative destruction becomes routine, and organized science is brought to bear on innovation. The entrepreneur loses political favor, and bureaucrats are ascendant. With the creative energy of the innovating entrepreneur lost, capitalism decays. This gloomy prediction is of great interest as a record of despair during World War II; as a prediction, it seems far from the mark 65 years later, and McCraw ignores it.

McCraw instead describes the complexity of Schumpeter’s view of socialism and its interaction with democracy. While Schumpeter believed that socialism was economically feasible in some times and places by mimicking capitalism, he was not at all sure how this would work out politically and socially. In his closing words, “As a matter of practical necessity, socialist democracy may eventually turn out to be more of a sham than capitalist democracy ever was.” I join McCraw in urging anyone interested in these questions to read this stimulating book. Like Keynes, Galbraith, and many economic-development theorists today, Schumpeter saw economic affairs as inextricably connected with politics, society, and ideology.

After the war, Schumpeter was elected president of the American Economic Association; he presented his presidential address in December 1948. McCraw describes it as a valedictory example of his subject’s characteristic blend of economic analysis, economic history, philosophy, and wit. In it, Schumpeter argued that there is no such thing as objective economics. Ideology is ever present, most obviously in the formulation of problems to solve. This admonition, true today as much as then, should not paralyze us, but rather be seen as a necessary indeterminacy in our results—as an economic Heisenberg principle. Although Schumpeter died in 1950, McCraw is right to insist that his contributions to our understanding of the economies in which we live are still vital today.

Peter Temin, JF ’65, Gray professor of economics at the Massachusetts Institute of Technology, was president of the Economic History Association in 1995-1996. His books include Iron and Steel in Nineteenth-Century America and The Fall of the Bell System.