The Magazine

Mr. Creative Destruction

Joseph Schumpeter and the truth about capitalism.

May 28, 2007, Vol. 12, No. 35 • By KEVIN R. KOSAR
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Prophet of Innovation

Joseph Schumpeter and Creative Destruction

by Thomas K. McCraw

Harvard, 736 pp., $35

Economics, Carlyle famously grumbled, is the "dismal science." With few exceptions (Adam Smith, Milton Friedman), its practitioners are little known to non-economists, and frequently mocked. Who can forget what Lyndon Johnson once said to John Kenneth Galbraith? "Did it ever occur to you, Ken, that making a speech on economics is a lot like pissin' down your leg. It seems hot to you, but it never does to anyone else."

So it's no small feat to make a jaunty read out of the life of an economist dead more than 50 years, and Thomas K. McCraw has done just that in his impressive new biography of Joseph Schumpeter. This is a result, in part, of McCraw's smooth prose and storytelling skills: The words just flow, and the reader can quickly gobble up the chapters, which seldom exceed 20 pages in length. Moreover, McCraw is well equipped for the topic, as the author of 10 volumes on business history and capitalism.

Without question, however, McCraw was aided by his subject, a flamboyant and complex figure whose life was marked with astonishing success and terrible sorrow. Joseph Alois Schumpeter was born in 1883 in Triesch, a small Moravian town in the Austro-Hungarian empire. His family was upper-middle class and prized stability; Schumpeters had resided there for four centuries and worked in the family textile business.

But a predictable life was not fated for Jozsi (pronounced YO-shee), as his parents called him. When he was four, his father died in a hunting accident. His mother turned this tragedy into an opportunity. She took her son 300 miles south to Graz, a city of 150,000, and within a few years had married a nobleman 33 years her senior, and then moved her family to an even bigger city, Vienna, which would serve as Jozsi's launch pad.

Now of a noble family, Schumpeter could enroll in the Theresianum, the empire's equivalent of Groton, where he studied mathematics, science, literature, history, and the classics, and was a top student. By graduation he had learned six languages. In 1901 he entered the University of Vienna, and made the most of it, hobnobbing with the upper social echelons and immersing himself in the study of law, history, and economics.

For all his efforts to project the persona of an old world aristocrat, young Schumpeter was a relentless striver. Both fop and grind, he dressed impeccably, bedded innumerable women, and was a tireless networker, all while studying to become the world's greatest economist. After graduating in 1905, Schumpeter exploded with activity. He traveled throughout Europe to meet eminent economists, married Gladys Seaver, the daughter of a Church of England official, started a law practice in Cairo, and wrote a 626-page book entitled The Nature and Content of Theoretical Economics. All in three years.

Then he bounced to a professorship at the University of Czernowitz, in what is now Ukraine, wrote another book (The Theory of Economic Development), wrangled a better job at the University of Graz, gave speeches at 17 American universities, and dashed off yet another volume (Economic Doctrine and Method: An Historical Sketch). By age 32 he had yielded more scholarship than most professors produce in their entire lives: Three books, 20 articles, and over 60 book reviews.

Throughout his life, Schumpeter would disapprove of academics who meddled in public policy. But after the collapse of the empire in 1918, he couldn't resist entering. His article, "The Crisis of the Tax State," prescribed a course for the economic recovery of the new state of Austria. The old state-directed economy should be replaced with an economy of competing firms, he wrote. Inflation ought to be kept low. Taxes should be set at a rate to generate sufficient revenues to repay debts, but not so high that they drive productive firms abroad. Critically, entrepreneurial dynamism must be fostered through the encouragement of credit and capital flows from abroad.

A few months later, thanks to his network of contacts, Schumpeter found himself Austria's first secretary of state for finance. He lasted less than a year, leaving the post in October 1919: His plans for rescuing Austria's economy were dead on arrival, the victim of internal politics and the victorious Entente Powers' desire to punish the Central Powers. Schumpeter's baptism in politics also commenced a largely disastrous period in his life. Rather than return to the University of Graz, Schumpeter went into banking. Initially he did well, but in 1924 Austria's stock market crashed, bankrupting Schumpeter. Meanwhile, his marriage had collapsed. In his early forties, the onetime wunderkind was reduced to giving speeches and writing articles to pay creditors.

Things improved the following year, however, when he married the love of his life, Annie Reisinger, and got a tenured professorship at the University of Bonn. But happiness was short lived; the next year his mother died, and two months after that, Annie died in childbirth and his newborn son four hours later. "All light," he wrote in his diary, had gone out of his days.

Schumpeter understood, however, that loss can beget gain. In a letter to a friend he wrote, "Everything now hangs on my ability to work. If so, the engine will keep running, even if my personal life is over." Over the next 23 years Schumpeter rebuilt his life. In 1932 he decamped to America for a posh permanent appointment at Harvard. There he met his third wife, economist Elizabeth Boody, earned enough to retire his debts, and again began producing a stream of articles, reviews, and major books, including Business Cycles; Capitalism, Socialism and Democracy; and the colossal History of Economic Analysis.

Although no longer the young fop who had shown up tardy to faculty meetings in jodhpurs and riding helmet, Schumpeter remained a flamboyant personage. Students and colleagues alike were impressed by his habit of drafting lectures afresh for every class and delivering them with gusto. During this period, as McCraw relates, Schumpeter expanded and deepened his already-impressive understanding of the nature of capitalism and its workings. He asked big questions and offered big hypotheses, and took a wrecking ball to many misconceptions and presumptions held by economists and the general public.

Anticipating behavioral economics by at least a half-century, Schumpeter argued that individuals do not behave as self-seeking utility maximizers. Homo economicus was a fantasy of economists. To understand economics you must study man as he is, living in contexts, and influenced by culture, prejudices, and idiosyncrasies. And speaking of everyman, one of his common errors is "the belief that the majority of people is poor because a minority is rich." Capitalism, Schumpeter counseled, is not a zero-sum game; the plain facts demonstrate that capitalist economies have significantly increased the wealth of everyone.

Looking at Great Britain and other national experiments with socialism, Schumpeter unleashed a devastating critique of Marxist economics. In the modern capitalist economy, he observed, there was inherent strife between capitalist and laborer. The reason is obvious: No barrier exists between the capitalist and labor classes.

"It is utter rubbish to argue that the worker is barred from social advancement," he declared. "One should never forget that today's entrepreneurs very often are themselves former workers and sons of workers." Those who saw socialism as the culmination of democratic development were confused. In point of fact, he wrote, "Modern democracy rose along with capitalism, and in causal connection with it." He also cautioned that socialism was more dangerous to freedom than capitalism because it permits government to legislate anything; the sphere of socialist governmental authority is unlimited.

In the United States, bashing big industrial firms and trust-busting had been in vogue since the turn of the 20th century. Schumpeter found this troubling because it rested on a delusive premise: that big means bad. Usually, Schumpeter argued, big companies have produced more products more efficiently. Furthermore, the fears of monopolistic profits were overblown. Competition from other firms would develop, lowering prices. Schumpeter took on the giant of the day, John Maynard Keynes, whose great error, he believed, was to blame the Great Depression on capitalism. Schumpeter thought that variables peculiar to the era, such as the disaggregated U.S. banking system, not capitalism, were to blame. Keynes's encouragement of government spending to stimulate the economy was wrongheaded and tempted politicians to rob Peter to pay Paul.

While Keynes allowed that "in the long run, we are all dead," Schumpeter counseled that, in the long run, capitalism will leave society better off. Capitalism is evolutionary, its development driven by "creative destruction" that "incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one." Entrepreneurs are the sparks for the conflagration, bringing new technologies to market and devising new means for operating firms. In little over a century we have seen tin foil-wrapped cylinders replaced by records, then by audio cassettes, then compact discs, and now MP3 players. Companies come and companies go. Farewell, Edison; hello, Apple.

When Schumpeter died in 1950, the world's best-known economist, newspapers around the world carried lengthy obituaries. When I asked some of the economists I know, who vary in age from 30 to over 60, whether they had studied Schumpeter in graduate school, all but one replied, "No." Only half-jokingly, one explained, "We don't really read books in graduate school, and certainly not histories of non-economic topics. Mostly we study formulas and graphs."

Dismal science, indeed--and too bad. We need more economists who can grapple with the big questions of capitalism and its development. As Schumpeter recognized, man affects economics and economics affects man.

Kevin R. Kosar is a writer in Washington.