Prophet of Innovation: Joseph Schumpeter and Creative Destruction

Published by EH.NET (November 2007)

Thomas K. McCraw, Prophet of Innovation: Joseph Schumpeter and Creative Destruction. Cambridge, MA: Harvard University Press, 2007. xi + 719 pp. $35 (hardcover), ISBN: 978-0-674-02523-3.

Reviewed for EH.NET by Richard N. Langlois, Department of Economics, University of Connecticut.

At the beginning of his long-awaited new biography of Joseph Schumpeter, Thomas McCraw describes the Vienna of Schumpeter’s birth as a “techno-romantic” civilization. It is a characterization, he says, that “applies as aptly to the man as to the country.” One might add that it also applies aptly to McCraw’s approach to Schumpeter. Unlike the several earlier Schumpeter biographies ? notably those of Robert Loring Allen (1991), Richard Swedberg (1991), and Wolfgang Stolper (1994) ? Prophet of Innovation is intended not primarily for academics but for the educated general reader. As such, the book falls into the biography subcategory of popular scientific writing, a genre that is almost inherently techno-romantic, painting in a romantic light not only its human subject but also its subject’s “technology” ? his or her theories, discoveries, and scientific breakthroughs. McCraw is at his best in conveying Schumpeter the man, providing an engaging and beautifully written portrait of this larger-than-life and often tragic figure. McCraw also works hard at weaving Schumpeter’s economics into the life story and at making the ideas supply their share of the drama. The result deepens our understanding of a fascinating and complex man and of the difficult times in which he lived, even if it does not necessarily sharpen our understanding of his economics or add much that is new to his biography.

It is testimony to the growing prominence of Schumpeter that he should attract as a biographer someone who is a distinguished business historian, an emeritus professor at Harvard Business School, and a winner of the Pulitzer Prize (for Prophets of Regulation (1984)). Like Schumpeter himself, McCraw sees Keynes as the relevant benchmark. Both Schumpeter and Keynes were born in 1883, and their careers comprehended more-or-less exactly the first half of the twentieth century. They were both products ? and perhaps embodiments ? of their backgrounds and training. Both were brilliant and quick witted, aristocratic each in his own way. And both died relatively young. For most of the second half of the twentieth century, of course, Keynes was the most famous name in economics, whereas Schumpeter was an obscurity remembered principally by a handful of students of technological change. By the 1990s, however, the tables had begun to turn. Keynesian economics was in decline and “Schumpeterian” economics on the ascendant. As Art Diamond (2006) has recently shown, citations to Schumpeter began to exceed citations to Keynes by the mid-1990s.

Schumpeter would probably have been astounded, although no doubt pleased, by these developments. As McCraw tells us, Schumpeter was well aware that he was founding no school, even musing at one point about his own lack of “leaderliness.” Whereas the founders of schools typically promote the careers of those who carry their message, Schumpeter famously promoted smart people irrespective of their views, including the Marxist Paul Sweezy and technicians like Paul Samuelson and Wassily Leontief. Indeed, one of the most puzzling of Schumpeter’s professional characteristics was his view that the economics profession ought to become more “scientific” and mathematical: for although he accurately anticipated what was in fact about to happen to economics ? and one wonders whether he would have thought that today’s profession has gone too far ? the narrow technical style of economics he was pushing was strikingly at variance with his own approach. McCraw is not alone in arguing that one of Schumpeter’s major contributions was to have produced broad social theory that combined economics with sociology and history.

In the end, however, the mid-century dominance of Keynes and the late-century rise of Schumpeter arguably have more to do with the fit of ideas to external events than with the skills and inclinations of the economists themselves in cultivating a following. The more firmly we find ourselves within the twenty-first century, the more we are coming to see the middle of the twentieth ? surely 1914 to 1945 and maybe 1914 to 1989 ? as a dark and (we may hope) aberrant time. Not surprisingly, economic historians have understood better than most that the long nineteenth century was the first era of globalization. Trade barriers declined, transportation and communications costs fell, and productivity and output increased. This was the era of empires: the British, the Ottoman, and the Habsburg in which Schumpeter was born. In the case of the Habsburgs, running a multi-ethnic empire required a careful balance of underlying national and ethnic tensions; and the result of that balancing was a relatively open, liberal, and intellectually vibrant society. Schumpeter was surely shaped by turn-of-the century Vienna, just as Keynes was no doubt the product of England and Bloomsbury. But it was the period after 1914 ? war, hyperinflation, depression, protectionism, nationalism, totalitarianism, more war ? that sharpened the intellectual contrast between the two men.

The contrast appears most clearly on the level of vision, a term Schumpeter popularized in his History of Economic Analysis. Keynes was fundamentally an economic pessimist in the manner of the nineteenth-century classical economists. His vision of the long run was that the marginal return to capital was in secular decline as capitalism used up all its investment opportunities; but his famous understanding of the short run was that clever intervention guided by smart people could keep the system afloat. Schumpeter’s vision was precisely the reverse. Schumpeter believed that capitalism’s potential was unbounded: an unending dynamic process of change ? creative destruction ? driven by entrepreneurship and leading to an ever-higher standard of life. For him, the best course was always to maintain good (i. e., pro entrepreneurial) policies and institutions and to sit tight through the destruction phases of creative destruction despite the inevitable political temptations to tinkering. It is not difficult, says McCraw, “to identify a Schumpeterian program ? at whatever level of analysis one chooses: the individual entrepreneur, the business firm, the industry, or even the country. At all levels, Schumpeter’s litmus test is whether the players are pursuing innovation and bringing about creative destruction. If they are, then the program is Schumpeterian. If they are not, it isn’t” (169). McCraw discusses in greater detail than previous biographers the popular articles Schumpeter wrote in the 1920s for The German Economist, a business magazine edited by his friend Gustav Stolper. I was not surprised by the extent to which Schumpeter comes off in these articles as a supply-sider (my term, not McCraw’s). Many articles favored low taxes, sound fiscal policy, and the encouragement of savings. But I was a bit surprised by the level of dirigisme Schumpeter was inclined to countenance. He favored “selective lending to companies in industries with high growth potential. ‘The strong ones, or those that can become strong, are to be strengthened, but the weak ones are not to be nursed.’ As conditions for public assistance, he argues, the companies must be forced to adopt innovative practices” (173).

In the years after 1914, and especially during the Great Depression, Keynes’s vision captured the temper of the times, whereas Schumpeter’s optimism seemed quaint and irrelevant (even though real GDP per capita in the U. S. had in fact almost doubled between 1914 and 1940). After World War II, however, and perhaps especially after 1989, it was Schumpeter who began to seem right on target. Capitalism was discovering investment opportunities literally unimaginable in 1940; liberalism, globalization, and freer trade were back; and economic historians (if not necessarily the general public) were coming around to the view that, far from being a massive meltdown of capitalism, the Great Depression was more like a colossal failure of the mechanisms of short-run tinkering with the monetary and banking systems.

Of course, Schumpeter was far from the only economist who was eclipsed by Keynes. Robert Skidelsky, Keynes’s biographer, has recently attempted to encapsulate why Keynes’s vision won out over that of another Austrian, F. A. Hayek. “Hayek believed that the market economy was a smoothly-adjusting machine in the absence of credit creation by the banking system. Keynes saw monetary ‘management’ by the central bank, which could include credit creation, as the only way to keep it stable. This was the pith of their debate. Keynes won it, because he made the more relevant statements” (Skidelsky 2006). Keynes won the debate with Schumpeter (in the Keynesian short run) for much the same reasons. But, in terms of pure economic theory, Schumpeter was far less the anti-Keynes than was a Hayek or a Friedman; in particular, Schumpeter’s monetary theory was far more Keynesian (or maybe even Post-Keynesian) than it was monetarist. Though he disagreed fundamentally with stagnationism, Schumpeter believed that the process of growth could never be made stable through monetary policy of any sort, since, in his view, the money supply was the endogenous product of the entrepreneurial process. Business cycles are thus an inevitable manifestation of creative destruction. In his massive 1939 tome Business Cycles, which he hoped would be a defining theoretical statement to rival The General Theory, Schumpeter sought the touchstone to these inevitable fluctuations in the scientistic necromancy of predictable cycles. The result was a kind of steampunk in which colorful historical details mingle with tantalizingly mathematical forces. McCraw rightly sees the book as a massive failure, not merely because it was out of step with the temper of the times but also because it was a near-unreadable jumble of facts and ideas. One might also add that as theory it was completely wrong.

In the longer-run, however, Schumpeter’s emphasis on entrepreneurship enabled him to capture the tenor of our times in a much-less-obviously political way than a Hayek or a Friedman. Whereas many economists since Cantillon and Smith have insisted that economic initiative would naturally flourish in an environment of good institutions and good economic policies, Schumpeter gave entrepreneurship an independent life and causative force. His ideas could thus become a rallying point for those who wished to theorize about, and to promote, growth and innovation while disagreeing about what constitute good institutions and good policies.

A scientific failure in mid-career does not move the engine of techno-romantic biography along unless it is quickly followed by triumph. In Schumpeter’s case, this came in the form of Capitalism, Socialism, and Democracy, a book Schumpeter wrote during the darkest years of the century. McCraw sees this work as a masterpiece, and a return to what was really Schumpeter’s great contribution all along: economic sociology rather than economic theory. Other biographers, notably Swedberg, would agree. But not all are persuaded. In his review of Prophet of Innovation in The New Republic, Robert Solow (2007) makes a point of minimizing the book’s importance, though he admits to a prejudice against big-think social science. And one cannot forget Frank Knight’s perhaps apocryphal dismissal of the book as “superbly entertaining dinner-table conversation.” In this matter I take McCraw’s side. Schumpeter’s most important contribution remains his theory of entrepreneurship. But Capitalism, Socialism, and Democracy is significant for the way it attempts to place that theory in the larger currents of social thought. It is not always right, by any means; but it is important for the broad ways of thinking it introduces. Indeed, I consider the book important even in an area where McCraw thinks otherwise. McCraw tells us that Schumpeter’s theory of democracy was largely anticipated by a tradition of American writing since colonial times of which Schumpeter seemed largely ignorant. True or not, this point misses the extent to which Schumpeter’s formulation of the issues anticipated and influenced modern public-choice economics.

Though written during World War II, the darkest period within a dark period, Capitalism, Socialism, and Democracy actually addresses what would become a central issue of the post-War period: the battle of capitalism against socialism. To his credit, and unlike the majority of commentators over the years, McCraw understands that Schumpeter’s brief in favor of socialism is not meant to be taken literally; it is parody, rhetorical deception. What comes through less clearly in McCraw’s treatment, however, is that, in a manner reminiscent of Thorstein Veblen, the black humor has a deadly serious function. Socialism may very well win. And it will be a tragedy.

From our perch in the twenty-first century, we may wonder why Schumpeter took full-blown socialism so seriously ? until we recall that, until 1989, the only economists who predicted a victory for capitalism were considered cranks. (We may also want to keep in mind that our second age of modern globalization may itself someday come to an end as well.) McCraw is more inclined to wonder why Schumpeter failed to see that a stable mixed economy is possible and desirable. After heaping justifiable praise on Schumpeter’s last major work, The History of Economic Analysis (published posthumously under the editorship of Schumpeter’s third wife, the economic historian Elizabeth Boody Schumpeter), and after documenting the signs of Schumpeter’s growing influence in present-day economic discourse, McCraw gives himself to wondering in epilogue how Schumpeter would have reacted to the modern world. Surely, says McCraw, Schumpeter would have decried the “accounting frauds, outrageous executive pay schemes, back-dating of stock options, and other looting of corporate treasuries by the very executives who were supposed to be their stewards. He would have considered these kinds of practices a betrayal of capitalism. All of them embodied the negation of the system Schumpeter had supported. They also represented reminders of the need for eternal vigilance and timely action by government regulators ? factors that Schumpeter, along with a large majority of his fellow citizens, persistently underestimated” (498). I am not surprised to hear the author of Prophets of Regulation taking this view. But I have a hard time imagining the author of Capitalism, Socialism, and Democracy doing so. Schumpeter would have been far more likely to say that the fall of Enron and related events are good examples of creative destruction cleaning up the system, and I would have expected him to warn against, rather than to embrace, the idea of subjecting capitalists to a New Class of regulators. Schumpeter ever outrageous, ever defiant. Wouldn’t that have made a better ? not to say more accurate ? ending to a gothic techno-romance?

References:

Allen, Robert Loring. 1991. Opening Doors: The Life and Work of Joseph Schumpeter. New Brunswick, NJ: Transaction Publishers.

Diamond, Arthur. 2006. “Schumpeter vs. Keynes: In the Long Run Not All of Us Are Dead,” paper presented at the International Joseph A. Schumpeter Society meeting, June 22, Sophia Antipolis, France.

McCraw, Thomas K. 1984. Prophets of Regulation. Cambridge, MA: Harvard University Press.

Skidelsky, Robert. 2006. “Hayek versus Keynes: The Road to Reconciliation.” Retrieved July 18, 2007, from http://skidelskyr.com/index.php?id=2,83,0,0,1,0.

Solow, Robert M. 2007. “Heavy Thinker,” The New Republic, May 21.

Richard N. Langlois is Professor of Economics at the University of Connecticut. His latest book, The Dynamics of Industrial Capitalism: Schumpeter, Chandler, and the New Economy (Routledge 2007), was a recipient of the 2006 Schumpeter Prize of the International Joseph A. Schumpeter Society. richard.langlois@uconn.edu.