Joseph A. Schumpeter, Outsider Looking In
Seventy years ago, on January 8, 1950, one of the most famous economists of the 20th century passed away at the age of 66, Joseph A. Schumpeter.
Seventy years ago, on January 8, 1950, one of the most famous economists of the 20th century passed away at the age of 66, Joseph A. Schumpeter. During and after his lifetime, he has been identified with two related ideas, the notion of the innovative entrepreneur and the imagery of the competitive market as a process of creative destruction. He was also a master of the history of economic ideas.
Properly understood, these two ideas of entrepreneurial innovation and the transformative creativity of market competition explain much about the amazing changes in modern economic times that have raised standards of living and filled the world with technological and other advancements that have radically advanced the way people live, and most of it for the better.
Schumpeter was born in Brno, in the Moravian region of the old Austro-Hungarian Empire (now part of the Czech Republic), on February 8, 1883. His father died when he was only four, and his mother moved to Graz, Austria, where she remarried a much older retired military officer. After attending a prominent Gymnasium (or exclusive high school) in Vienna, Schumpeter entered the University of Vienna in 1901, where he earned his doctoral degree in the faculty of law in 1906, with a specialization in economics.
In 1919, he briefly served as Minister of Finance in the new post-World War I Republic of Austria government, and in 1921 became the president of a small Viennese bank that went bust in 1924. In 1925, Schumpeter accepted a professorship at the University of Bonn, Germany, a position that he held until 1932, when he moved to the United States with an appointment at Harvard University in Boston, which he held until his death in 1950.
Schumpeter’s Roots in the Austrian School
It was during his student days at the University of Vienna that he came under the intellectual influence of two of the leading members of the Austrian School of Economics, Eugen von Böhm-Bawerk (1851-1914) and Friedrich von Wieser (1851-1926). While already in his university days Schumpeter strayed from these “Austrian” roots, their personal impact clearly remained with him for the rest of his life.
Not long after Böhm-Bawerk died in August 1914, Schumpeter wrote a lengthy and most moving appreciation of him. He had participated in Böhm-Bawerk’s famous seminar at the University of Vienna (with many other outstanding students, including Ludwig von Mises), and the experience left a permanent impression concerning the qualities of academic professionalism, intellectual integrity, and political uprightness that he had found in everything that Böhm-Bawerk did.
Schumpeter also had an affectionate attachment to Wieser as teacher and mentor. In addition, Wieser showed Schumpeter the connections between economics, history, and sociology that became hallmarks of much of his own writings over the decades. But Wieser seems to have also been an influence in Schumpeter’s understanding of the entrepreneur as “the leader” of a private enterprise who guides, directs, and brings about great changes in what is produced, as well as how, where, and for what purposes.
At the age of 25, Schumpeter demonstrated his already wide interdisciplinary reading when he published The Nature and Essence of Economic Theory (1908). While containing a concise explanation and defense of methodological individualism – the idea that all social phenomena emerge from the actions and interactions of individuals, and can only be understood on the basis of the logic of individual human decision-making – he showed his orientation toward Leon Walras’s mathematical, general equilibrium approach to economics, and his agreement with a “positivist” method concerning the nature of scientific inquiry that economics should be primarily grounded in the quantitative and the measurable, compared to the “subjectivist” focus of the Austrian Economists.
Schumpeter on Entrepreneurship and Dynamic Change
But it was his 1911 volume, The Theory of Economic Development (English translation, 1934), that established for the rest of his life an international reputation as an original and creative thinker. Using as a starting point the “circular flow” of an economy in general equilibrium – the idea that all supplies and demands for consumer goods and the means of production are perfectly and continuously in coordinated balance in and through time – Schumpeter introduced the idea of “the entrepreneur.”
The entrepreneur is the leader who breaks out of the routine, Schumpeter says, who has the will, authority, and “weight” to bend the routinized processes of production out of the inertia and rationality of the existing knowledge and ways of doing things. Through the entrepreneur, economic “development” is introduced into the economic system, the elements of which represent the marketing of new or qualitatively better goods; new methods of production through which goods are produced; the opening of new markets that dramatically change various economic activities; the discovery and utilization of new resources; and radical changes in the organizational structure of industry.
But his image of the entrepreneur is not the image of the “heroic” leader of military combat or political struggle. Instead, Schumpeter argues,
“The entrepreneurial kind of leadership . . . consists in fulfilling a very special task which only in rare cases appeals to the imagination of the public. For its success, keenness and vigor are not more essential than a certain narrowness which seizes the immediate change and nothing else . . .
“Yet the personality of the capitalistic entrepreneur need not, and generally does not, answer to the idea most of us have of what a ‘leader’ looks like, so that there is some difficulty in realizing that he comes within the sociological category of leader at all.
“He ‘leads’ the means of production into new channels. But this he does not by convincing people of the desirability of carrying out his plan or creating confidence in his leading in the manner of a political leader – the only man he has to convince or to impress is the banker who is to finance him – but by buying them or their services, and then using them as he sees fit.
“He also leads in the sense that he draws other producers in his branch after him. But as they are his competitors, who first reduce and them annihilate his profit, this is, as it were, leadership against his own will.
“Finally, he renders a service, the full appreciation of which takes a specialist’s knowledge of the case. It is not so easily understood by the public at large as a politician’s successful speech or a general’s victory in the field, not to insist on the fact that he seems to act – and often harshly – in his individual interest alone.
“We shall understand, therefore, that we do not observe, in this case, the emergence of all those effective values which are the glory of all other kinds of social leadership.”
Schumpeter uses these elements to explain the possible workings of a bank credit cycle through which these innovative entrepreneurs are funded to bring about radical transformations in the interdependent structures of the market economy. The existing “circular flow” of production is broken out of by the creation of bank credit that enables the innovative entrepreneurs to outbid and draw away the necessary means of production from other businessmen for the transformative changes in the means and methods and purposes of production to be introduced.
At the end of the day, the entrepreneur’s successful and profitable innovations force his market rivals to copy and improve upon his creative changes, with old ways of producing and marketing pushed out of the market, until, finally, the cycle of change reaches its end; at which point the “new” economy is dramatically different from the old one that it has replaced. And, then, the process begins anew . . .
The Non-Neutrality of Money as a Dynamic Element of Change
As a complement to this theory of credit expansion to fund and transform production that carries with it a form of the business cycle, Schumpeter in 1918 published a long essay on “Money and the Social Product” in which he attempts to explain the determination of the value of money.
But included in this analysis is an exposition of the inherent “non-neutrality” of all changes in the quantity of money, which in a temporal-sequential process brings about both temporary and permanent changes in the structure of relative prices, production activities, and the distribution of income, depending upon the “injection” points through which additions to the money supply are introduced into the economic system. Schumpeter explained:
“To begin with, increases in the quantity of money never occur uniformly for all people. Further, people are never completely aware of the nature of the process, so that, at least for some time, they act as if they received higher incomes, when the sum of [real] incomes remains constant. For both reasons, prices never rise uniformly – neither the prices for consumer goods relative to each other nor the prices of consumer goods relative to those of the means of production. Thereby the price rise ceases to be merely nominal. It means a real shift of wealth on the market for consumer goods and a real shift of power on the market for the means of production, and it affects the quantities of commodities and the whole productive process. No doubt, not all these effects are permanent … But very frequently such reestablishment of the status quo is impossible. Newly-won positions may be permanently held, and old ones permanently lost, and much in the life of the economy may thereby change – as forms of business organization, direction and methods of production, etc.”
Schumpeter then proceeds to offer a series of possible scenarios of how and for what purposes such increases in the supply of money might come about, each with its own impacts and effects through time. For instance, an increase in the supply of gold-money that enters the economy either as additional consumer spending or as additional reserves in the banking system; or an increase in paper money to cover government deficit spending, such as during a time of war; or the creation of additional bank credit that lowers market rates of interest and stimulates additional borrowing for investment purposes; or an increase in the demand for investment borrowing that is funded through creation of additional bank credit. It is this latter case that forms the basis of Schumpeter’s theory of the business cycle arising from new entrepreneurial innovation.
This attention to the non-neutrality of money was one element of the “Austrian” approach to monetary and business cycle theory that Schumpeter never abandoned. As he said much later in his posthumous, History of Economic Analysis (1954):
“The Austrian way of emphasizing the behavior or decisions of individuals and of defining the exchange value of money with respect to individual commodities rather than in respect to a price level of one kind or another has its merits, particularly in the analysis of an inflationary process; it tends to replace a simple but inadequate picture by one which is less clear-cut but more realistic and richer in results.”
These themes remained continual elements in Schumpeter’s writings over the decades, and many of the essays on these and related topics may be found in a collection of his shorter pieces edited by Richard V. Clemence under the title, Essays on Entrepreneurs, Innovations, Business Cycles, and the Evolution of Capitalism (1951). The volume includes Schumpeter’s short but scathing 1936 review of John Maynard Keynes’s The General Theory of Employment, Interest, and Money.
He questions Keynes’s simplistic reduction of all economy-wide fluctuations to an interaction between an Aggregate Demand Curve and an Aggregate Supply Curve; he considers Keynes’s references to “propensities” to consume by income earners to be “in the worst style of a bygone age,” since “such a ‘propensity’ is again nothing but a deus ex machina” to reach conclusions that Keynes wants to reach; and he is scornful of Keynes’s ignoring of “the most powerful propeller of investment,” that being entrepreneurial transformations in the means and methods of production, which are doubtful to ever dry up as long as human imaginations remain at work. As for Keynes’s insistence that all that is ever needed to assure “full employment” is paper money and government deficit spending, Schumpeter concluded the review with the following observation:
“The less said about the book the better. Let him who accepts the message expounded rewrite the history of the French old regime in some terms as these: Louis XV was a most enlightened monarch. Feeling the necessity of stimulating expenditure, he secured the services of such expert spenders as Madame de Pompadour and Madame du Barry. They went to work with unsurpassed efficiency. Full employment, a maximum of resulting output, and a general wellbeing ought to have been consequence. It is true that instead misery, shame and, at the end of it all, a stream of blood. But that was a chance coincidence.”
Business Cycles and the Dynamics of Creative Destruction
Schumpeter’s constant interest in monetary and business cycle matters was also shown in what he had clearly hoped would be recognized as a “masterwork,” his two-volume Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process, which appeared in 1939 (Vol. 1 and Vol. 2). At one level it was supposed to be his alternative to Keynes’s The General Theory. Unfortunately, being extremely dense, difficult to read, and nearly impossible to easily find the central threads to which the exposition was meant to lead the reader, Schumpeter’s massive book was poorly received, and has left little noticeable impact within the economics profession. Its early chapters, however, show his often-acute insights into the nature and limits of equilibrium analysis in economics, and the work in general demonstrates his wide knowledge of economic and social history.
Schumpeter is, perhaps, most famous for coining the phrase “the perennial gale of creative destruction” to capture his conception of the constant and continuous workings of the dynamic and entrepreneurially driven capitalist system, as found in his 1942 work, Capitalism, Socialism and Democracy. Here he argues that the static and timeless equilibrium-focused notions of “perfect competition” and “monopoly” as presented in economics textbooks are hopeless and worthless for appreciating and understanding the true dynamic nature of capitalism and entrepreneurship. Attention must be on the dynamic changes and transformations that traverse years and sometimes decades, not the frozen moments of an unrealistic “now” captured in an economic diagram of demand and cost curves.
Or as Schumpeter says:
“In dealing with capitalism we are dealing with an evolutionary process . . . that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.
“The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates. In capitalist reality as distinguished from its textbook picture . . . The kind of competition which counts . . . [is] the competition from the new commodity, the new technology, the new source of supply, the new type of organization . . . The competition that commands a decisive cost or quality advantage . . . It is hardly necessary to point out that competition of the kind we now have in mind acts not only when in being but also when it is merely an ever-present threat. It disciplines before it attacks. The businessman feels himself to be in a competitive situation even if he is alone in his field.”
In spite of his seemingly explicit rejection of the “Austrian” approach to economic theory, therefore, it is in his writings on entrepreneurship, the market process, and the “dynamics” of real world competition that one sees a continuing influence of his “Vienna” roots in his conception of the market economy and its workings.
Schumpeter’s Fatalism and Sarcasm on the Coming of Socialism
His book, Capitalism, Socialism, and Democracy, is also famous for another element as well: Schumpeter’s deep fatalism and pessimism that capitalism was doomed and socialism (in some form) was inevitable. He was clearly impressed and influenced by Karl Marx as a sociologist analyzing the tendencies and directions of capitalist society. But Schumpeter was anything but a Marxist, though always fascinated by the Marxian worldview and its appeal in the intellectual and practical world in which he lived.
Indeed, several of his friends were surprised when back in 1919 he agreed to participate in a postwar German government commission to investigate possible means and methods for the “socialization” of the coal and related industries in Germany, since they all knew his negative views on socialism in general. He commented that, “If somebody wants to commit suicide, it is a good thing if a doctor is present.” He was not sure if actual socialism, fully implemented, could work or not, but, “At any rate, it will be an interesting experiment to try out.”
Schumpeter’s almost witty bemusement about the coming of the socialist epoch that seemed to be ahead drove some interlocutors crazy. For instance, the Austrian banker, Felix Somary (1881-1956), who had been in Böhm-Bawerk’s seminar at the University of Vienna with Schumpeter and Mises, recounted in his book, The Raven of Zurich (1960), a meeting that he had arranged between the famous German sociologist, Max Weber (1864-1920), and Schumpeter at a Vienna Café around this time. The conversation turned sour as the discussion shifted to the recent Russian Revolution. As recounted by Somary:
“The talk turned to the Russian Revolution, and Schumpeter expressed satisfaction that socialism was no longer an abstract theoretical notion but would now be tested in the real world. Weber said with some heat that communism at the Russian stage of development was a crime – he knew the language and followed Russian affairs closely. He added that developments in Russia would lead to unheard-of human misery and a terrible catastrophe.
“‘That may well be,’ said Schumpeter, ‘but it would be a good laboratory to test our theories.’
“‘A laboratory heaped with human corpses!’ rejoined Weber.
“‘Every anatomy class is the same thing,’ Schumpeter shot back. . .
“Weber became more vehement and raised his voice, as Schumpeter for his part became more sarcastic and lowered his. All around us the café customers stopped their card games and listened eagerly, until the point when Weber sprang to his feet and rushed out into the Ringstrasse, crying, ‘This is intolerable!’ . . . Schumpeter, who had remained behind with me, only smiled and said, ‘How can someone carry on like that in a coffee house!’”
Schumpeter’s interest in socialist ideas also can be seen in his well-known essays, “The Sociology of Imperialisms” (1919) and the “Social Classes in an Ethnically Homogeneous Environment,” (1927) the first of which is meant to be a critical response to the Marxian and Leninist theories of imperialism as an end-stage of the capitalist process. Schumpeter sees late 19th and early 20th centuries European imperialism as an atavism, a throwback, to a pre-capitalist mode of conquest and exploitation; capitalist society, with its institutions of peaceful trade and voluntary contract, is the opposite of imperialist command and coercion, Schumpeter reasons. His analysis of social classes is meant to challenge, again, the Marxian idea that “class” is defined by the individual’s relationship to ownership of the means of production.
Schumpeter’s Wistfulness on the Passing of the Liberal Era
In numerous places in his writings Schumpeter explains the classical liberal world before the First World War in words and phrases that clearly show his sadness of its passing and the arrival of variations on the social and economic collectivist themes. For instance, with a wistful nostalgia, Schumpeter explains in, “An Economic Interpretation of Our Times,” a series of lectures delivered in Boston in 1941, that,
“[Before 1914, under capitalism] the world was rapidly internationalizing itself . . . Free movement of commodities, restricted if at all only by customs tariffs; freedom, unquestioned in principle, of migration of people and of capital; all this facilitated by unrestricted gold currencies and protected by a growing body of international law that on principle disapproved of force or compulsion of any kind and favored peaceful settlement of international conflicts . . .
“At home, practically all civilized countries professed allegiance to the democratic ideal . . . The freedom of the individual to say, think, and do what he pleased was also within very wide limits generally accepted. This freedom included the freedom of economic action: private property and inheritance, free initiative and conduct were essential elements of that [capitalist] civilization. What they characteristically called government interference was held to be justified only within narrow limits. The state had to provide a minimum of framework for the lives of individuals and this framework it had to provide with a minimum of expenditure. The ideal of the cheap state had its natural complement in the postulate that taxation should be kept within such limits that business and private life should develop in much the same way as they would have done if there had been no taxation at all.
“That civilization was essentially rationalist and utilitarian. It was not favorable to cults of national glory, victory, and so on. That civilization required rationalist credentials for everything it was doing. It counted the costs of wars and did not back the glory as an asset.”
Like in Capitalism, Socialism, and Democracy, which appeared in print the following year, Schumpeter discussed the reasons why he was fearful that the very material and cultural prosperity that came with liberal capitalism generated forces and factors that undermined the sustainability of that wonderful world of freedom and economic well-being. But it was clear that for Schumpeter it was a sad misfortune that free market liberalism was destined to be a passing chapter in the history of modern mankind. He reiterated the shining qualities of the liberal society once more when he wrote the contribution on “Capitalism” for the 1946 edition of the Encyclopedia Britannica, in he which he emphasized,
“The familiar features of [capitalism and] its political complement, liberalism, were laissez-faire, in particular free trade, and ‘sound money’ (meaning unrestricted gold currency) . . . A pacific, though far from pacifist, attitude toward foreign nations . . . Unprecedented respect for personal freedom not only in economic but in all matters . . .The principle of leaving individuals to themselves and of trusting their free interaction to produce socially desirable results.”
Schumpeter as a Master of the History of Economic Ideas
Schumpeter also was a master of the history of economic ideas. In 1912, he published Economic Doctrine and Method, which though relatively brief in length (only 200 pages in the 1954 English translation), shows a breadth and depth of reading and insight that might be considered unusual for a young man of 29 years of age. He concisely and clearly summarizes many of the important trends in the development of economic thought from the 1700s to the early years of the 20th century.
Over the years he wrote a number of essays on famous economists and their ideas, including biographical and interpretive studies of Karl Marx, William Stanley Jevons, Leon Walras, Carl Menger, Alfred Marshall, Vilfredo Pareto, Friedrich von Wieser, and John Maynard Keynes. Of particular note, as pointed out earlier, is his lengthy and detailed appreciation of the life and work of his Austrian teacher, Eugen von Böhm-Bawerk. They are included in, Ten Great Economists: From Marx to Keynes (1951).
But his true masterwork in the field of economic ideas was his posthumously published, History of Economic Analysis (1954), which was partly unfinished at the time of his death in 1950. Running for 1,200 pages, the reader is awe-struck by the immense knowledge and insight Schumpeter possessed about the evolution and development of economic ideas from ancient times to the present, in extraordinary detail and richness over virtually every aspect of economic theory and practice. Even when the reader does not agree with all of his arguments or interpretations, one remains in the company of and learns from one of the great minds of 20th-century economics.
Schumpeter Left No “Schumpeterian” School
Schumpeter always presented himself as an eclectic and a social scientist standing above and outside of the sectarian bickering of “schools of economic thought.” He never fostered or generated a “Schumpeterian” school, as one might speak of a Ricardian “classical” approach or of Keynesian Economics.
As such, his writings have been admired, criticized and sometimes utilized by others, especially his conception of the entrepreneur and entrepreneurial innovation and change. But they have always, like himself, stood outside of the mainstream of economics, with most economists not knowing how to incorporate his ideas of “creative destruction” or entrepreneurial innovation within the mostly equilibrium models of neoclassical, mainstream economics.
In my view, this is due to the fact that Schumpeter, like his “Austrian” intellectual cousins whom he chose to disassociate himself from, always saw the real essence of economics to be outside of and beyond the confines of mathematical equilibrium, a world of creative and innovative human actors introducing change and initiating market processes that just cannot easily (or at all) be made to fit within the constraints of the mathematical techniques that he insisted were the proper tools of a truly “scientific” economics.
Unable to escape from the Walrasian equilibrium economics he so much admired from the time he was a young man, Schumpeter could not construct an alternative schema for a market process analysis that his views of entrepreneurship and dynamic competition cried out for. And, thus, many of his “positive” contributions to economics remain outside of and unutilized by the mainstream of the economics profession.
Finally, when British economist Lionel Robbins (1898-1984) reviewed Schumpeter’s History of Economic Analysis in 1955, he ended with the following description of the last time he saw Joseph Schumpeter:
“The last time I met Schumpeter was on a river picnic in the middle 1930s. He had turned up unexpectedly from the United States on the day of our annual seminar outing at the [London] School [of Economics]; and he was immediately co-opted as an honorary member, so to speak, and pressed into joining the excursion.
“It was a lovely day in June; and as we glided down the Thames between Twickenham and Datchet, I can still see him, cheerfully ensconced in the prow of our ship, surrounded by the eager spirits of the day, Nicky Kaldor, Abba Lerner, Victor Edelberg, Ursula Hicks . . . [with] the four fingers and thumb of each hand pressed against those of the other, discoursing with urbanity and wit on theorems and personalities. So I conceive of this book, a splendid excursion down the river of time, with good talk and magnificent vistas.”
This captures, in my view, the experience of reading virtually all of Joseph Schumpeter’s writings – “a splendid excursion down the river of time, with good talk and magnificent vistas” – and as such he remains, in many ways, one of those timeless and uniquely thought-provoking contributors to economics, but an outsider always looking in.
[Originally Published at AIER]