Powell's Books - Review-a-Day - Prophet of = Innovation: Joseph Schumpeter and Creative Destruction by Thomas K. = Mccraw, reviewed by The New Republic Online

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Prophet of Innovation: = Joseph=20 Schumpeter and Creative Destruction
by Thomas=20 K. Mccraw=20

Heavy Thinker =
A Review by Robert M. Solow=20

I knew Joseph Schumpeter only in = the=20 last five years of his life, from 1945 until his death in = 1950, at=20 the age of sixty-six. To say that I knew him is actually a = bit of an=20 exaggeration. First as a returning undergraduate and then as = a=20 doctoral student in economics at Harvard, I attended his = courses on=20 advanced economic theory and the history of economic = thought. The=20 theory lectures bordered on incoherent; they alluded to = everything=20 but analyzed nothing. He would say: "Of course you know = about X or=20 Y, so I do not have to go into detail." But we didn't know = about X=20 or Y, as he must have realized. The history lectures were = also=20 disappointing. I do not remember where they began, but at = the end of=20 the term they had barely reached Adam Smith. The course felt = like a=20 stage display of multilingual erudition.

More generally, Schumpeter seemed to be playing the role = of grand=20 seigneur, and he tended to flatter where flattery was not = due, no=20 doubt satirically. All this went along with his reputation = as a=20 casual and easy grader. We used to say that he threw the = exam books=20 up a staircase: the ones that stuck at the top got an A, the = ones=20 that fell to the bottom an A minus. I was surprised to learn = that in=20 Austrian universities he had the reputation of a stern=20 taskmaster.

You would not gather any of this from Thomas K. McCraw's = account=20 of those last years. He records that Schumpeter was troubled = by the=20 slow course of his own work, and unhappy about his relations = with=20 his departmental colleagues; but he says that Schumpeter was = enthusiastic about his teaching and successful at it. McCraw = may=20 have been misled because Schumpeter's style was always = flamboyant,=20 entertaining, and exotic, and many students enjoyed the = spectacle.=20 Maybe it is just as well to slide over Schumpeter's failings = at the=20 end. He was past his peak; and the economics profession was = moving=20 in a direction -- rigorous theory couched in mathematical = terms --=20 that he had always professed to admire but simply could not = practice=20 himself. There is good evidence that earlier cohorts of = Harvard=20 students found a slightly younger Schumpeter inspiring and a = force=20 for high intellectual standards.

In 1940 Schumpeter seriously contemplated leaving Harvard = to=20 accept a financially equivalent and organizationally more = attractive=20 offer from Yale. His senior colleagues at Harvard -- some = able, more=20 of them drab -- sent him a letter urging him to stay; it = said the=20 right things, but was perhaps a little perfunctory. A much = more=20 urgent, heartfelt, and mind-felt letter was signed by = twenty-six=20 junior faculty and advanced graduate students. The authors = included=20 the flower not only of Harvard-trained economists of that = time, but=20 of the future of American economics. You have to admire the = man who=20 evoked those words from those people.

I wish I had known him then. It is to Schumpeter's = eternal credit=20 that, at a time when mediocrity often cottoned to mediocrity = in=20 Harvard economics, he stood always for intellectual quality = and=20 energy, regardless of ideology, ethnicity, or social = position.=20 McCraw makes this very clear, and understands its = importance.

In recollecting Schumpeter, it is hard to tear oneself = away from=20 the exotic manner, the dubious politics, the carefully = crafted=20 image, the hidden self-doubts, the convoluted life story, = the=20 complicated relations to three wives and several non-wives. = McCraw=20 covers all these in great and often fascinating detail. He = makes=20 full use of Schumpeter's diaries, which is where we learn of = his=20 self-doubt; it certainly was not evident in his public = manner. On=20 some issues -- in his politics especially -- he tends to = give=20 Schumpeter the benefit of the doubt, though not foolishly or = blindly. One could have been harsher about Schumpeter's = belief that=20 Franklin Roosevelt was aiming at dictatorship, even if there = were=20 respectable members of the Union League Club who agreed. = Still, what=20 really matters are Schumpeter's writings -- the books and a = couple=20 of essays; and that is where I have something to add. I do = not fully=20 agree with McCraw's judgments.

In my view -- and that of most contemporary economists, I = believe=20 -- Schumpeter's most original and most lastingly significant = book=20 was Theory of Economic Development, which appeared in = 1911=20 (and was translated into English in 1934). It was at the = University=20 of Czernowitz, not far from the beginning of his career as = an=20 economist, that he worked out his conception of the = entrepreneur,=20 the maker of "new combinations," as the driving force and=20 characteristic figure of the fits-and-starts evolution of = the=20 capitalist economy. He was explicit that, while = technological=20 innovation was in the long run the most important function = of the=20 entrepreneur, organizational innovation in governance, = finance, and=20 management was comparable in significance.

Innovation is not the same thing as invention. Anyone can = invent=20 a new product or a new technique of production. The = entrepreneur is=20 the one who first sees its economic viability, bucks the = odds,=20 fights or worms his way into the market, and eventually wins = or=20 loses. Each win means profit for the entrepreneur and his = backers,=20 and it also means a jog upward for the whole economy. In the = course=20 of this process, which cannot possibly run smoothly, many=20 businesses, individuals, and institutions, themselves = founded on=20 earlier successful innovations, will be undermined and swept = away.=20 Schumpeter called this birth-and-death process "creative=20 destruction," and realized before anyone else that it was = the main=20 source of economic growth. There is no feasible alternative = for=20 capitalism; this is capitalism. Here is a = characteristically=20 strong statement: "Without innovations, no entrepreneurs; = without=20 entrepreneurial achievement, no capitalist returns and no = capitalist=20 propulsion. The atmosphere of industrial revolutions -- of=20 'progress' -- is the only one in which capitalism can = survive."

The picture generated by classical and neoclassical = economics had=20 none of this dynamism, turbulence, and intrinsic = uncertainty.=20 (Malthus was perhaps a partial exception.) Smooth trends and = stationary states, equilibria of one kind or another, = predominated.=20 There is a sense in which Schumpeter could claim to have = been the=20 progenitor of a torrent of modern research that analyzes the = dynamics of profit-driven innovation and innovation-driven = economic=20 growth. Even creative destruction has been translated into=20 equations. (The pioneers were Philippe Aghion and Peter = Howitt, and=20 others have followed.)

Schumpeter derived from this analysis a lasting bias in = favor of=20 big business. "American opinion is so antibig business," he = wrote,=20 "precisely because big business has made the country what it = is now=20 and in doing so it has set the standard of the American = soul: who is=20 not a part of big business feels he does not meet the = standard and=20 by compensation turns against it." Clearly a successful = innovation=20 confers, in his view, at least a temporary monopoly. Without = the=20 lure of those monopoly profits, there would be no incentive = for=20 anyone to bear the risks of entrepreneurship. Schumpeter = believed=20 that large firms were both the source and the result of = successful=20 innovation; and so tampering with them would be dangerous. = But the=20 issue is more subtle than that. The English economist John = Hicks=20 once remarked that "the best of all monopoly profits is a = quiet=20 life," meaning that a seller with monopoly power might = settle for=20 less than the largest possible profit in order to avoid = attracting=20 rivals who would have to be beaten off amid turmoil and = uncertainty.=20 There is much evidence that having to compete with best = practice is=20 itself an important spur both to innovation and to other = aspects of=20 industrial performance. Maybe there is an optimal intensity = of=20 competition.

I think that this is Schumpeter's main legacy to = economics: the=20 role of technological and organizational innovation in = driving and=20 shaping the growth trajectory of capitalist economies. Whole = subfields of economics now pursue the subject of the care, = feeding,=20 and consequences of innovation, using qualitative and = quantitative,=20 historical and mathematical methods. McCraw gives only a few = pages=20 to Theory of Economic Development. He certainly = understands=20 that it is fundamental, but he does not place it as the = summa=20 that it is.

I agree with him, however, that the two-volume = Business=20 Cycles of 1939 was a massive failure, in both senses of = the=20 phrase. (I still have the yellowing copy that I bought as a = student.=20 It was, and still is, essentially unreadable.) Schumpeter = probably=20 intended it as his entry in a competition with Keynes's = General=20 Theory, which appeared three years earlier, but it made = no=20 visible impression on the profession or the public. The book = is full=20 of detail about the rise and fall of firms, technologies, = and=20 industries, but it does not rise to the status of a theory = of=20 business cycles. It is more like a map on the scale of one = foot=20 equals two feet: you see the potholes, but you do not learn = much=20 about the scenery.

McCraw does not really discuss the main piece of new = intellectual=20 machinery that Schumpeter hoped to impose on the jumble of=20 business-cycle history to convert it into a comprehensible = tale.=20 That was a system of three oscillations or waves = superimposed on one=20 another: a forty-month Kitchin cycle, a roughly ten-year = Juglar=20 cycle, and a long Kondratieff cycle of about fifty years. = (Kitchin=20 and Juglar were economists of considerable obscurity, and=20 Kondratieff only a little less.) I don't suppose that anyone = under=20 the age of eighty remembers any of this, though there remain = a few=20 devotees of the Kondratieff cycle. To see six complete = cycles, you=20 would have to go back nearly three hundred years. It makes = for good=20 stories, maybe too easily.

This three-cycle scheme is a pointer to the main = theoretical flaw=20 in the book. Schumpeter wanted to place the entrepreneurial=20 innovation process at the heart not only of episodic growth = but also=20 of the repetitive "business cycle" (or at least of the two = longer=20 species of cycles). McCraw seems to go along. But it does = not work.=20 After considerable experimentation, economics has given up = on any=20 such periodicities. Whatever was true of the more distant = past (when=20 the data were poor anyway), the texts of modern history do = not fall=20 into a pattern of regular, repetitive cycles. Instead, "the = business=20 cycle" has become shorthand for the series of irregular, = short-run,=20 aggregative fluctuations of varying duration, magnitude, and = --=20 probably -- causation that we call prosperity and recession. =

Schumpeter had a rise-and-fall mechanism in mind. The = monopoly=20 profits collected by a successful entrepreneurial firm = attract=20 imitators and competitors, many of which are financed by = fresh=20 credit. This activity eventually erodes the initial profits; = and=20 then the time is ripe for another innovation, if one comes = along.=20 There is obvious truth to this story, but it is far from = being a=20 theory of economy-wide fluctuations.

Business Cycles was surely a great disappointment = to its=20 author. Schumpeter had, essentially single-handedly, written = this=20 detailed 1,100-page narrative of events in Britain, Germany, = and the=20 United States as seen through the lens of creative = destruction. It=20 must have used up a dreadful amount of even his enormous = energy. And=20 the world of economics just kept on arguing about = Keynes.

In 1942, Schumpeter published Capitalism, Socialism, = and=20 Democracy, which was reprinted and translated many = times. It was=20 his most successful book by a wide margin, and it is = certainly a big=20 canvas. McCraw thinks of it as a landmark of = twentieth-century=20 social science, and gives it many pages of description and=20 discussion. I do not think it comes close to being that = important;=20 but I have to admit that I have a general distrust of = ambitious,=20 overarching attempts to capture a whole socioeconomic system = in a=20 few grand generalizations.

The book reiterates the standard Schumpeterian vision of=20 capitalist turmoil and transformation, with the = entrepreneurs as the=20 indispensable heroes. This time he suggests a mechanism = within=20 capitalist society that (inevitably?) causes it to undermine = itself.=20 The children and grandchildren of successful entrepreneurs,=20 precisely the people with the right DNA, are seduced by = inherited=20 wealth into intellectual pursuits, the arts, aristocratic = habits,=20 perhaps even into left-wing or at least anti-capitalist = ideologies.=20 It is not the proletariat that blows up the capitalist = edifice,=20 which is in fact good for the proletariat. It is the second=20 generation of successful entrepreneurs that lets the ground = floor=20 decay.

Is this in fact a common pattern? Is it more likely than = simple=20 chance would imply? Schumpeter can tell good tales, but it = is hard=20 to know if they are the only, or the typical, tales. He also = makes=20 the rather paradoxical argument that, with long habit, even = the=20 process of innovation itself becomes routinized and = depersonalized,=20 and therefore weakened. Can he really have believed that = successful=20 capitalism is essentially a romantic virtue? There is = little=20 doubt that the heroic view of entrepreneurship came = naturally to=20 Schumpeter. Capitalism, Socialism, and Democracy is = the kind=20 of swan song that yields willingly to Schumpeter's "vision" = without=20 a lot of critical analysis.

The chapters on socialism are written almost ironically. = Many=20 passages accept, mock-seriously, the benefits in efficiency = and=20 equity that have always been claimed for socialism and=20 public-spirited central planning; but then come all the=20 qualifications, Orwellian and worse, often drawn from the = experience=20 of the Soviet Union. Saving, for instance, can simply be = extracted=20 by the state. "Hardships and abstinence' have been imposed = such as=20 in capitalist society could ever have enforced." Under = socialism,=20 however, this rigor "presumably will command that moral = allegiance=20 which is being increasingly returned to capitalism." = Capitalism,=20 Socialism, and Democracy is a well-done polemic from a = supremely=20 sophisticated Central European. I don't know if it can be = classified=20 as social science, but I do think that most of it is = true.

Which brings us to the "democracy" in Schumpeter's title. = He was=20 not a democrat by instinct or by reflection. He had little=20 confidence in the ability of the average citizen to vote=20 intelligently, or even in his own long-run interest. His = book asks=20 if democratic socialism is possible. The conclusion is that = perhaps=20 it is possible in principle, but almost surely not in = practice.=20 Democratic capitalism is what we have, but democratic = resentment and=20 demo- cratic ignorance tend to work against capitalist = success,=20 either by accepting socialism or by fostering = over-regulation.

For these reasons, Schumpeter could not conceive that a = permanent=20 mixed economy was a viable proposition. He called it = "capitalism in=20 an oxygen tent." For him, capitalism is the civilization of = a few=20 family fortunes and broad inequality. Democracy, he thought, = must=20 turn out to be "laboristic," and therefore inimical to = capitalist=20 success. This conclusion was a major error, as McCraw says. = It has=20 been soundly contradicted empirically by the sixty years and = counting since World War II. Nor was this a mere slip of = judgment.=20 Schumpeter's mistake was rooted in his political and social=20 attitudes and even, to some extent, in his characterization = of=20 entrepreneurship and the dynamics of capitalism.

As against McCraw, I cannot see this book as a major work = of=20 "social economics." My guess is that Schumpeter did not = really think=20 so either. (He said as much, but that could have been false=20 modesty.) When the publisher asked for new material for = later=20 editions, Schumpeter was content to tack on minor things = that he had=20 written about the postwar economy, especially the view that = the=20 Soviet Union had been the big winner, having picked the = pockets of=20 Churchill and Roosevelt (whom Schumpeter hated anyway). This = is not=20 how you treat your life's great work.

I will not discuss=20 History of Economic Analysis, edited and published = after his=20 death by his wife Elizabeth Boody Schumpeter. It is very = long and=20 very recondite. Instead, I think one can learn more about = Schumpeter=20 from two books that he did not write. During his prime = years, he was=20 episodically working at a book about money. One can see why = he might=20 have tried. He had spent some years in private banking, and = a=20 shorter unsuccessful interval as minister of finance in = Austria. He=20 had published a couple of relevant essays; and Theory of = Economic=20 Development emphasizes the creation of credit by the = banking=20 system as part of the process by which banks finance = would-be=20 entrepreneurs. But he did not have much aptitude for = monetary=20 theory, or any important idea to transmit. When the bits he = had=20 written down were published as a book in the 1970s, it = attracted=20 little attention.

Then, in his later years, he thought about writing a = treatise=20 that would summarize "Schumpeterian economics." Most = especially he=20 contemplated a "preliminary volume" that would summarize the = treatise to come, and would tell his story in a style that = could=20 reach a broader professional and non-professional audience. = This was=20 clearly intended as his answer to Keynes. The internalized = rivalry=20 with Keynes, his exact contemporary, for the title of = World's=20 Leading Economist seems to have nagged frequently at = Schumpeter.

But he seemed not to understand what Keynesian economics = was=20 about, or why it won over the younger generation. For = example, he=20 described Keynes as the apostle of consumer spending (in = contrast to=20 his own emphasis on innovational investment). But in fact = consumer=20 spending is passive in Keynes's General Theory. The = driving=20 force of the aggregate economy is actually investment = spending; and=20 Keynes put great causal weight on "animal spirits" and "the = state of=20 long-run expectations," both of which are much more akin to=20 entrepreneurial drive.

Similarly, Schumpeter charged Keynes with being a = "stagnationist"=20 (in contrast to his own belief that there was no natural = limit to=20 entrepreneurial energy and innovation). This is a more = complicated=20 matter. The Keynesian framework could accommodate = stagnationist=20 ideas about the drying-up of profitable investment = opportunities;=20 and in other hands it did. Keynes certainly did not admire=20 "money-grubbing," and he would have classified a hot-to-trot = Schumpeterian entrepreneur as a money-grubber. That is not=20 stagnationism. It is probably more accurate to say that = Keynes erred=20 in a different way, by thinking that consumers might become = satiated=20 as their incomes rose and could be left with neither the = wish to=20 spend nor the capacity to enjoy leisure.

It is possible to see Keynesian and Schumpeterian ideas = as=20 complementary. Keynes is about short-run economic = fluctuations=20 brought about by erratic variations in the willingness of = investors=20 and governments to spend; Schumpeter is about the long-run=20 trajectory driven by the erratic march of technological = progress.=20 This complementarity only became clear later, after both men = had=20 died, when economic growth became an explicit objective of = public=20 policy and topic of systematic analysis. Schumpeter was left = frustrated by the younger generation's affinity for his = rival. In=20 any case, the "preliminary volume" never materialized.

The world turns. Today, some sixty years after their = deaths,=20 Schumpeter's star probably outshines Keynes's. The business = cycle=20 has receded in importance, partly because the large = industrial=20 economies have sprouted a more stable structure, and partly = because=20 the lessons that Keynes taught have been learned by central = banks=20 and finance ministries. Instead, long-term economic growth = has moved=20 to the top of the political and intellectual agenda, and = that was=20 Schumpeter's topic. As Robert Lucas memorably put it, once = you have=20 begun to think about economic growth, it is hard to think = about=20 anything else. It is a pity that troubled old Schumpeter did = not=20 live to see the triumph of his obsession.

There was another source of Schumpeter's unhappiness = during that=20 last decade, and of his tendency to withdraw from his = colleagues. He=20 had been ambivalent -- worse than ambivalent, some thought = -- about=20 the war itself. His wife had many associations with Japan, = where she=20 had done research. More importantly, Schumpeter believed = that a=20 strong Germany was all that kept western civilization from = being=20 overrun by the Bolshevik hordes. He did not exactly want to = see=20 Germany win; but he did not want to see Germany lose. He = would=20 certainly have preferred to see Western Europe and the = United States=20 join Germany in a struggle against the Soviet Union. Would = he have=20 swallowed Hitler if that were necessary? There is no way to = know,=20 but the fact that one can ask the question exposes the = problem. The=20 man was all problems, and one very important idea.

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