Joseph Alois Schumpeter (1883-1950) was one of the greatest economists of the 20th century—commonly bracketed with such giants as Keynes, Hayek and Friedman. He is best known for his theory of “creative destruction”—the view that the capitalist system progresses by constantly revolutionising its economic structure. New firms, new products, new technologies continually replace old ones. Since innovation comes in fits and starts, the capitalist economy is naturally, and healthily, subject to cycles of boom and bust. The agent of this revolutionary process is the heroic entrepreneur: the individual owner in the 19th century, big business in the 20th. Innovation needs its reward, hence a dynamic economy is one which allows the innovator huge profits. Temporary monopoly is nature’s way of allowing innovators to gain from their inventions. Short-run inequity is the price of long-run progress.
Along with Schumpeter’s positive contribution went a persisting critique of conventional economics, whose concern with static problems of allocation in perfectly competitive markets rules out change and the role of the entrepreneur. But Schumpeter’s speculations ranged far beyond this, into the question of the durability of a civilisation which lives by continually destroying what it has created—a line of thought which went back to Marx in his Communist Manifesto. It may well be that Schumpeter has more to tell us about the nature of capitalism than the new breed of market idealists spawned by globalisation or by such 20th-century apostles of stabilisation as Keynes.
At least, that is the argument of Thomas K McCraw in Prophet of Innovation, his new biography of the great Austrian economist. It is a fine book, well paced and readable. There are plenty of good photographs, of Schumpeter himself and of the important people and places in his life. The theme of creative destruction appears against the background of Schumpeter’s own family uprooting, the dissolution of the Austro-Hungarian empire, the turmoil of the interwar years, and the restless, and tragic, circumstances of his adult personal life. McCraw puts it like this: “Over the years he reinvented himself many times…Thinking not of where he started but of how he might move forward, he was well suited to grasp the mindset of the entrepreneur… [In Vienna] he learned that one’s identity in a rapidly changing world might come more from innovation than inheritance; that exchanging security for opportunity could bring great rewards; and that for someone with his gifts almost anything was possible.”
A thinker’s background cannot tell us everything about his thought, but it can tell us a great deal, and McCraw exploits his opportunities with great skill, while also giving the reader a lucid, non-technical account of Schumpeter’s ideas. His main insight concerns the effect on Schumpeter’s thinking of the impact of capitalist business on the still largely feudal order of central and eastern Europe. It was the speed of the transformation, and extent of the ensuing dislocation, which led him to reject the static equilibrium models of British economics, derived from a society where economic change was evolutionary and institutions very stable. Unlike his exact contemporary Keynes, Schumpeter always saw economics from the standpoint of the innovative businessman, not of the treasury or central bank.
One of McCraw’s failings is that he does not give a sufficiently concrete account of Schumpeter’s first 30 years. He bursts on the intellectual scene already a celebrity. The steps by which he reached his eminence are largely missing. Unlike Keynes, who never strayed far from Cambridge, Schumpeter was uprooted from his ancestral home. His family origins were solid Catholic German bourgeoisie, long settled in a couple of small towns in Moravia, now part of the Czech Republic. But when he was four, his father, who owned a textile business, died in a hunting accident. His mother Johanna, determined to secure a larger stage for herself and her son, moved to the provincial capital Graz, remarried a general, and, with her elderly aristocratic husband, shifted to Vienna where the 11-year-old Schumpeter was enrolled in a top gymnasium, Theresianum, proceeding from there to the University of Vienna, where he graduated in Roman and canonical law in 1906.
This double transplantation cost Schumpeter his roots, but fed his ambition. Johanna was one of those mothers who invested all her energies in the creation of a star. Schumpeter shared his mother’s ambition for him to succeed socially as well as intellectually. Outside the study, Schumpeter was an almost invented character. He started mixing with Austria’s aristocracy—as a young man he even fought a duel. He became a compelling conversationalist. He impressed old professors and dazzled young students, but he had no close male friends of his own age. The hour in the morning Keynes devoted to his investments, Schumpeter was reputed to spend on his toilette. “The new graduate,” McCraw writes, “dressed like a dandy, spent money freely, and carried on frequent liaisons with willing women.” He used to say that his three ambitions were to become the greatest economist, the greatest horseman and the greatest lover in the world, and only the decline of the cavalry had thwarted the fulfilment of all three.
McCraw could have made more of the mystery of Schumpeter’s appearance. It had more of the Levant than of Europe. Many people assumed he was Jewish, but there is no evidence of this, nor, as McCraw rightly emphasises, of any expressions of antisemitism. But Schumpeter made his strange looks a compelling feature of his personality. “He held his head high and tilted slightly backward, acccentuating his prominent chin and making his 5’8′ 145-pound frame look a little bigger than it was.”
Schumpeter possessed a prodigious capacity for work, but one would like to know more about his work habits and what he worked on. There is nothing about his eight years at Theresianum except that he emerged fluent in six languages. At the University of Vienna “it did not take Schumpeter long to find that he had a special gift for economics,” but apart from a single reference to his attendance at Bohm-Bawerk’s seminar on Marx, we learn little about what he actually studied, or the quality of his degree. He had no “special gift” for mathematics—but how much maths could he do? Two years after his graduation—aged 25—he published a 600-page book on economic method, and three years later a slenderer volume, The Theory of Economic Development (1911), which “launched his rise to stardom” from a temporary teaching job in a provincial Austrian university. On a visit to England in 1907, which confirmed a lifelong Anglophilia, the great lover unexpectedly acquired a well-connected English wife, Gladys Seaver, 12 years older than himself, with whom he was not “madly” in love. “Perhaps,” McCraw speculates not unreasonably, “it was again an issue of identity, of trying to reinvent himself as a continental aristocrat and an English gentleman.”
The Theory of Economic Development is Schumpeter’s first statement of the crucial role that entrepreneurs play in breaking up old and creating new structures and stimulating new wants, and the role of bank credit in financing innovation—themes he was to pursue for the rest of his life. It also established what was to become the main line of his defence of capitalism—that its destructiveness was inseparable from its creativity. Schumpeter was not a complete non-interventionist like his fellow members of the Austrian school, Ludwig Mises and Friedrich Hayek, but he was to come out decisively against the systematic stabilisation policy recommended by Keynes for fear it would end progress prematurely.
A surprising omission in McCraw’s account is any discussion of Schumpeter’s little book, Imperialism and Social Classes (1919), which tried to explain the the collapse of the Austro-Hungarian empire after the first world war. Bourgeois societies, Schumpeter argued, are by nature peaceful, but German and Austro-Hungarian politics had been dominated by a military aristocracy: “a machine of warriors, created by the wars that required it, which now creates the wars it requires.” Like Keynes, Schumpeter had vainly advocated a negotiated peace to save the European civilisation he loved. In 1919, he briefly became minister of finance in the rump Austrian state, but his stabilisation plan was powerless against hyperinflation. Here again McCraw lets down the reader: he tells us that Schumpeter’s ministerial career lasted six months, but nothing about how it ended.
Two devastating blows in short succession brought a “belated onset of… maturity.” His attempt to make money as a banker foundered in 1924 with the collapse of a bogus glassmaking company whose loans he had guaranteed. An adverse legal judgment, while exonerating him from wrongdoing, left him debts which took years to pay off and a blemished reputation. He wrote: “The promises of wealth and the threats of destitution that [capitalism] holds out, it redeems with ruthless promptitude.” Meanwhile, Schumpeter had fallen desperately in love with Annie Reisinger, 20 years his junior, the beautiful daughter of the concierge of the apartment building in which he had grown up. Inventing a middle-class background for her, and ignoring the inconvenient fact that he was still married to Gladys Seaver, Schumpeter rushed her to the altar in November 1925. A few months later came the death of his adored mother and, in August 1926, of Annie herself in childbirth. Schumpeter never fully recovered from this shattering of his hopes for wealth and personal happiness. “Everything now hangs on my ability to work,” he wrote to a friend. “If so, the engine will keep running, even if my personal life is over.” His celebrity lectures would pay off his debts; his serious work would be monuments to his Hasen—his mother and Annie.
The rest of his life was devoted to teaching, thinking and writing. He moved from a chair in Bonn in 1925 to one at Harvard in 1932, where he remained till his death in 1950. On the way, he acquired two devoted helpmates, Mia Stöckel, who managed his personal business in Bonn, and Elizabeth Boody, whom he married in 1937. At Harvard, he became a campus celebrity, holding court each afternoon in a coffee shop by the Widener Library. He was devoted to his students, and generous with his attention. Although Schumpeter insisted that “scientific” work must be kept free from the policy taint, he could not avoid politics completely in the 1930s and 1940s. Elizabeth had a soft spot for Japan, and Joseph regarded Soviet Russia as a greater danger than Nazi Germany—views which brought the couple to the attention of the FBI in the war.
McCraw provides excellent accounts of the three big books Schumpeter wrote at Harvard—Business Cycles (1939), Capitalism, Socialism and Democracy (1942) and his superb History of Economic Analysis, published after his death in 1954. Capitalism, Socialism, and Democracy sums up most of what Schumpeter had been thinking for the previous 30 years. It was also one of the most influential books of the 20th century. It transferred the defence of capitalism from the ground of the superiority of markets over central planning to that of the superiority of capitalism over socialism as an engine of technological progress, but one inseparable from huge costs in terms of disruption and inequity, and because of that, inherently fragile. Capitalism’s fatal flaw is exactly what Marx discerned in the Communist Manifesto: it creates a vested interest in social unrest by undermining the traditional ruling class without being able to create a ruling class of its own. To his own question “Can capitalism survive?” Schumpeter answered “No, I do not think that it can.” As JK Galbraith remarked, “Men of property and high corporate position do not rally to such friends.”
Unlike Hayek, Schumpeter defends the theoretic viability of socialism, but argues that the conditions of its arrival (except possibly in Britain) will be such as to make it intolerably oppressive. McCraw rightly points out the irony in Schumpeter’s treatment of socialism—which led some reviewers to believe that he was advocating it—but somehow misses the tragic implications of the thesis: capitalist civilisation is doomed, but its alternative, socialism, is appalling. He also, it seems to me, underestimates the huge importance Schumpeter’s discussion of democracy has had on the development of modern political science, particularly in the two propositions that politicians are entrepreneurs in votes, and that the true function of democracy is to choose leaders, not policies. What Schumpeter was arguing was that elitist democracy, or oligarchy, could give societies the advantages of dictatorship plus liberty. He saw Britain as the epitome of such a system. But in general he doubted the ability of contemporary democracies to exercise the required self-restraint.
Schumpeter was one of the dazzling minds of the 20th century, but was he a great economist? Unlike Smith, Ricardo and Keynes, he created no new theory, founded no new school. At Harvard, he taught many brilliant graduate students, some of them future Nobel laureates, but they went to his seminars more to dispute than to learn. He could certainly “do” economics, and indeed his erudition in the history of the discipline was unparalleled, but he viewed it largely from outside—that is, sociologically and historically. His major contributions to our understanding of the capitalist system stand outside the main development of the discipline, which has been towards increasing mathematical precision in stating the conditions for market equilibrium. As McGraw rightly emphasises, entrepreneurship can’t be fitted into formal models; we can’t predict the future because we can’t predict the appearance of exceptional individuals. Or as Schumpeter himself wrote: “We do not know enough in order to form valid generalisations or even enough to be sure whether there are any generalisations to form.”
Given the magnitude of Schumpeter’s achievement outside economics, this reader is left with a question: does economics, as taught and practised in the economics departments of top universities and published in top journals, rather than as Schumpeter understood it, have anything of importance to tell us about the conditions of contemporary economic and political life? Or is it, like the glass-bead game in Herman Hesse’s novel Magister Ludi, a kind of intellectual chess played by an elite of secular priests?