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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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.