Joseph Schumpeter

Published: Jul 2013

Joseph Schumpeter, an Austrian-American economist and political scientist, is much honoured as an economic prophet: in 1983 Forbes pronounced him a better guide to the tumultuous world economy than John Maynard Keynes; and in 1986 John Kenneth Galbraith described him as “the most sophisticated conservative of this century”. One of the most influential economists of the 20th century, Schumpeter popularised the term “creative destruction” in economics.

On 17th September 2009, The Economist inaugurated a blog on business and management named “Schumpeter”. The initial Schumpeter blog praised him as a “champion of innovation and entrepreneurship”, whose writing showed an understanding of the benefits and dangers of business that proved to be far ahead of its time. Subsequently the blog has covered cutting-edge innovations, including most recently 3D printing, sustainable start-ups and wi-fi offloading. There are Schumpeter lectures, Schumpeter societies and Schumpeter prizes. In addition, his theories live on in the hearts and minds of policy makers. For example, the EU’s innovation programme, and its main development plan, the Lisbon Strategy, are influenced by Schumpeter.

Beyond his economic prowess, he was infamous for his public persona. Schumpeter claimed that he had set himself three goals in life: to be the greatest economist in the world, to be the best horseman in all of Austria and the greatest lover in all of Vienna. He duelled with a university librarian over restrictions on lending privileges and often taught classes while wearing jodhpurs.

Early life

Schumpeter was born in 1883 in Trešt, in what is today part of the Czech Republic, and his father and grandfather were local textile entrepreneurs. The family moved to Vienna, the capital of the Austro-Hungarian Empire, after the death of his father in 1887. Living in one of the world’s leading centres for economics piqued Schumpeter’s interest in economics. He received his doctorate in 1906 and, after some years abroad – mainly in England and Egypt – he settled down to a conventional career as an economist. During the years 1908-1914, while still in his twenties, Schumpeter published three brilliant books in economics and advanced to full professor at the University of Graz. One of these, ‘The Theory of Economic Development’ (1911; English translation 1934), was the first major work by an economist that was devoted entirely to entrepreneurship. It became a classic and by far Schumpeter’s most influential economic work.

As Schumpeter’s professional success grew, so did his personal ambitions and he yearned for a high political position in the Austro-Hungarian Empire. After World War I the Austro-Hungarian Empire disintegrated, which may have dashed his dreams, except that in 1919 the Social Democrats asked him to be Secretary of State for Finance in the new Austrian Republic. However, he was sacked in November of that year amid hyperinflation and broader economic collapse. He received a banking licence in lieu of a pension.

After a decade of lecturing at different universities, as a Professor at Graz and Bonn and as a visiting Professor at Harvard University in 1927 and 1928, lecturing at Hitosubashi University Japan in 1929 but failing to gain a chair at Berlin in 1931, Schumpeter was appointed a professor at Harvard in 1932, in succession to Frank Taussig. There he taught Wassily Leontief, Paul Samuelson and John Kenneth Galbraith among others. In 1939 he published the two-volume ‘Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process’, which was overshadowed by Keynes’ ‘General Theory’.

In 1942 Schumpeter released the more popular ‘Capitalism, Socialism and Democracy’, at once praising large corporations as the engines of economic growth and warning that a Gramscian new class of government bureaucrats (wearing New Deal clothes or otherwise) might lead to the triumph of socialism. It featured praise of capitalism as ‘creative destruction’ – “creative destruction is the essential fact about capitalism. Stabilised capitalism is a contradiction in terms.”

Galbraith’s assessment of this book was that it must be read “not for the agreement or disagreement it provokes but for the thought it invokes”.

Creative destruction

The bulk of his immense theoretical contribution was directed toward an investigation into entrepreneurial capitalism as a transitory, historical phenomenon. This analysis of the growth of capitalism was tied to both a general theory of social classes and a detailed inquiry into the nature and function of the capitalist class.

Schumpeter’s two greatest insights were that innovation is the driving force not only of capitalism but also of economic progress in general, and that entrepreneurs are the agents of innovation. Entrepreneurs are possessed by “the dream and the will to found a private kingdom”, but they are confronted with obstacles. Innovation is hard to produce and harder to sustain: all successful businessmen stand on ground that is “crumbling beneath their feet”.

Schumpeter was among the first to lay out a clear concept of entrepreneurship. He distinguished inventions from the entrepreneur’s innovations. Schumpeter pointed out that entrepreneurs innovate not just by figuring out how to use inventions, but also by introducing new means of production, new products, and new forms of organisation.

Innovation by the entrepreneur, argued Schumpeter, leads to gales of “creative destruction” as innovations cause old inventories, ideas, technologies, skills, and equipment to become obsolete. The question is not “how capitalism administers existing structures, but how it creates and destroys them.” This creative destruction, he believed, causes continuous progress and improves the standards of living for everyone.

Schumpeter argued that some degree of monopoly is preferable to perfect competition, which was the prevailing view as a way to maximise economic well-being. Competition from innovations, he argued, is an “ever-present threat” that “disciplines before it attacks.” He cited the Aluminum Company of America as an example of a monopoly that continuously innovated in order to retain its monopoly.

Schumpeter and Keynes

Born just months apart and dying within a few years of each other, Schumpeter and Keynes were contemporaries in the best sense, as illustrated by the former’s respectful obituary of the latter. Austrian-born American management consultant, Peter Drucker, backs up the assumption that the two men were not antagonists. “Both challenged longstanding assumptions. The opponents of Keynes were the very ‘Austrians’ Schumpeter himself had broken away from as a student, the neoclassical economists of the Austrian School. And although Schumpeter considered all of Keynes’s answers wrong, or at least misleading, he was a sympathetic critic,” wrote Drucker in his essay, ‘Modern Prophets: Schumpeter and Keynes?’ (1983).

When Keynes’s masterpiece, ‘The General Theory of Employment, Interest and Money’, came out in 1936, Schumpeter, by then the senior member of Harvard economics faculty, told his students to read the book and also that Keynes’s work had totally superseded his own earlier writings on money. Keynes, in turn, considered Schumpeter one of the few contemporary economists worthy of his respect.

According to Drucker, the differences between Schumpeter and Keynes went much deeper than economic theorems or political views. The two saw a different economic reality, were concerned with different problems, and defined economics quite differently. For example, Keynes operated entirely within the classical economics framework. Economics was the equilibrium economics of Ricardo’s 1810 theories, which dominated the 19th century. Keynes’s key question was the same question asked at that time: “How can one maintain an economy in balance and stasis?”

Schumpeter, on the other hand, held that a modern economy is always in dynamic disequilibrium. Schumpeter’s economy is not a closed system like Newton’s universe – or Keynes’s macroeconomy; it is forever growing and changing – more biological rather than mechanistic in nature. The ‘Theory of Economic Development’ begins with the assertion that the central problem of economics is not equilibrium but structural change.

Classical economics considered innovation to be outside the system, putting it in the category of “outside catastrophes” with earthquakes, climate or war, which have profound influence on the economy but are not part of economics. Schumpeter insisted that, on the contrary, innovation – or entrepreneurship that moves resources from old and obsolescent to new and more productive employments – is the very essence of economics and most certainly of a modern economy.

Seminal works

The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle (German 1911/English 1934)

In this classical analysis of capitalist society Schumpeter proclaims that economics is a natural self-regulating mechanism when undisturbed by “social and other meddlers.” Despite weaknesses, he argues, theories are based on logic and provide structure for understanding fact. He proceeds to demonstrate that there are underlying principles in the phenomena of money, credit and entrepreneurial profit that complement his earlier theories of interest and the business cycle.

Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process (1939)

Schumpeter focuses powerfully on the historical role of technological innovation in accounting for the high degree of instability in capitalist societies. He aims to analyse empirically the actual process of economic development using historical and statistical material based on the theoretical framework he developed in earlier writings.

Capitalism, Socialism and Democracy (1942)

Schumpeter’s contention that the seeds of capitalism’s decline were internal, and his equal and opposite hostility to centralist socialism, have perplexed, engaged and infuriated readers since the book’s publication. By refusing to become an advocate for either position, Schumpeter was able both to make an original contribution and to clear the way for a balanced consideration of the most important social movements of his and our time.

History of Economic Analysis (1954)

Published posthumously, this classic text provides a complete history of economic theory from Ancient Greece to the end of World War II. Topics addressed include the techniques of economic analysis, contemporaneous developments in other sciences and the sociology of economics.

Other works include:

  • The Nature and Essence of Theoretical Economics (1908).

  • Economic Doctrine and Method: An Historical Sketch (1914).

  • The Crisis of the Tax State (1918).

  • Depressions: Can We Learn From Past Experience? (1934).

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