Rediscovering Schumpeter: the Power of Capitalism — HBS Working Knowledge

RESEARCH & IDEAS Rediscovering Schumpeter: The Power of Capitalism Q&A with: Thomas McCraw Published: May 7, 2007 Author: Sean Silverthorne

Economist Joseph Schumpeter was perhaps Schumpeter many years ago, as an the most powerful thinker ever on innovation, undergraduate, and I've enjoyed reading his Schumpeter believed the entrepreneurship, and capitalism. He was also works ever since. But the main reason I wrote one of the most unusual personalities of the this book is the tremendous resonance his ideas exact opposite, and of 20th century, as Harvard Business School have had with my HBS students and with course he was right. professor emeritus Thomas K. McCraw shows businesspeople. in a new biography. Read our interview and I think Schumpeter is the most penetrating This is an extremely hard lesson to accept, book excerpt. Key concepts include: analyst of capitalism who ever lived. He saw particularly by successful people. But business • Schumpeter's ideas on capitalism, things other people didn't see, partly because he is a Darwinian process, and Schumpeter often entrepreneurship, and innovation still have lived in 7 different countries. He also served likened it to evolution. The creative destruction great resonance to students and briefly as Austria's finance minister and worked can occur within a large innovative company businesspeople today. for 3 years as an investment banker, where he (Toyota, GE, Microsoft), but it's much more made a fortune that he promptly lost in a stock likely to happen with start-ups, particularly market crash. So he wasn't a typical academic, since they now have so much access to venture If capitalism was the most influential single even though he spent most of his career as a capital. Schumpeter, by the way, was one of the economic and social force of the 20th century professor, including almost 20 years at Harvard. first economists to use that term. He wrote an (and continuing today), there is no better guide As for my title, here's the quotation that article in 1943 in which he speaks of "venture to understanding its power and complexity than inspired it: "Without innovations, no capital." famed economist Joseph Schumpeter, says entrepreneurs; without entrepreneurial Harvard Business School's Thomas K. achievement, no capitalist returns and no Q: Capitalism, Socialism and Democracy McCraw. “I think Schumpeter is the most capitalist propulsion." Schumpeter wrote this is perhaps Schumpeter's best-known work. penetrating analyst of capitalism who ever sentence during the Great Depression of the What makes it so rich and provocative even lived. He saw things other people didn't see.” 1930s. Many, many smart people of that time half a century later? McCraw, a past winner of the Pulitzer Prize believed that technology had reached its limits A: Chapter 7, "The Process of Creative for History, has written a new biography, and capitalism had passed its peak. Schumpeter Destruction," is only 6 pages long, but it Prophet of Innovation: Joseph Schumpeter and believed the exact opposite, and of course he perfectly captures the essence of capitalism. Creative Destruction, which weaves together was right. The 2 chapters preceding and the 2 following it threads of social, business, and economic flesh out the argument. So in the space of a little histories to illuminate Schumpeter's life and Q: Schumpeter introduced the term more than 40 pages, we have probably the work. A central theme details how “creative destruction” and championed the richest material ever written on the broad Schumpeter's insights help us understand how role of the entrepreneur in both start-ups subject of capitalism. The rest of the book is the forces of capitalism, innovation, and and in established companies. What can full of provocative ideas on politics, economics, entrepreneurship continue to transform the business leaders take away from his and society, from ancient times to the present. world today. development of these ideas? Schumpeter wrote some parts of the book in Making the story even more compelling is A: The main takeaway is the absolute the form of satire. In his long analysis of Schumpeter's charismatic personality. relentlessness of creative destruction and socialism, for example, he seems to be arguing Something of a dandy, Schumpeter (1883-1950) entrepreneurship. In a free economy, they never that it is a superior system. But this whole was a hit with women, adored by students, and stop—never. Schumpeter wrote that all firms section is really an elaborate shell game. As both made and lost a fortune in a matter of must try, all the time, "to keep on their feet, on Jonathan Swift, the greatest satirist writing in years. He also once initiated a sword fight with ground that is slipping away from under them." the English language put it, "Satire is a sort of a librarian—and won. So, no serious businessperson can ever glass wherein beholders do generally discover McCraw, the Isidor Straus Professor of completely relax. Someone, somewhere, is everybody's face but their own." Some readers Business History Emeritus, discusses his always trying to think of a way to do the job actually came away from Schumpeter's book research and thoughts on Schumpeter's legacy better, at every point along the value chain. believing that he was a socialist. In fact, he was in this e-mail interview. Whatever has been built is going to be one of the most ardent defenders of capitalism destroyed by a better product or a better method of his time. But he was very subtle about it, Sean Silverthorne: What attracted you to or a better organization or a better strategy. trying above all to force his readers to think for research and write about Schumpeter? And themselves. why the title Prophet of Innovation? Thomas McCraw: I first encountered Q: You compare reading his books with

given out heavy assignments, the librarian had listening to Beethoven's symphonies. What refused to allow the students to check out the initial one of the twenty-first: the sudden powers did Schumpeter command as a assigned books, and when Schumpeter threw a collapse of communism, for seventy years a writer? tantrum (he was only 26, and had just started serious challenger to capitalism; the riotous A: I made this comparison for 2 reasons. teaching), the librarian challenged him to a prosperity of the 1990s, when entrepreneurs First, Beethoven's music is not always easy to duel. Schumpeter won the duel by cutting a became folk heroes; the ensuing epidemic of understand—in contrast, for example, to small slice out of the librarian's shoulder. The corporate scandals, which bankrupted Mozart's. (Mozart is the most widely recorded two men later became good friends, and the shareholders and employees and disgraced of all classical composers, and Beethoven students got access to the books. capitalism itself; then the scourge of second.) You have to be patient with Like many geniuses, Schumpeter held international terrorism, portending warfare Beethoven, and listen very carefully, sometimes himself to impossibly high standards, and he without end; and finally the spectacular over and over, to get the full message. constantly brooded that he wasn't living up to economic gains in many parts of the Another reason for the comparison is that them. There was extraordinary tension between world—most notably China, which combined a Beethoven's music is grandiose and extremely his devotion to rationality ("I have given my life new capitalist economic system with an old romantic, and the same can be said of to reason," he once wrote in his diary), and the communist political regime. Schumpeter's writing—very unusual for an overwhelming power of his emotions. He was How can one understand these issues? Why, economist. But because capitalism is much an intellectual prodigy, and, like many former after seven decades of struggle, did capitalism more than just an economic system, Schumpeter boy wonders, was surprised to find that he triumph over communism? Are exorbitant made himself more than an economist. He was could not work during his 40s and 50s at the executive pay schemes and continual the most erudite economic scholar of his time, furious pace he had set during his 20s. Even so, accounting frauds corruptions of capitalism or and perhaps of all times. he did some of his very best work in middle its natural state? When people ask about age. Capitalism, Socialism and Democracy, for terrorists “Why do they hate us so much?” what Q: Today, what would Schumpeter tell us example, appeared when he was 59. part does capitalism play in the definition of about the evolution of capitalism in the 21st “us”? How long can China and other countries century? There's no denying his sustain their economic progress without A: Several economists, including Larry granting more political liberties to their people? Summers and Brad DeLong, have said that the personal appeal, especially Some of the clearest guides to these kinds of 21st century is going to be "the century of questions come from Schumpeter, who assessed Schumpeter," and I agree. The reason is that to women and to scholars capitalism as an expression of innovation, innovation and entrepreneurship are flowering and students of both sexes. human drama, and sheer havoc—all going on at all over the world in unprecedented once. He told of capitalism in the way most fashion—not only in the well-publicized cases Then, too, he suffered some dreadful people experience it: as consumer desires of China and India, but everywhere except personal tragedies, such as the death of his aroused by endless advertising; as forcible jolts those areas that foolishly continue to reject 23-year-old wife in childbirth, and of his up and down the social pecking order; as goals capitalism. newborn son 4 hours later. This was the pivotal reached, shattered, altered, then reached once The word "globalization" is accurate event of his life. In the months and years that more as people try, try again. For capitalism, enough, but if anything it understates the case, followed, he drew on the great depth of his and for Schumpeter personally, nothing was in part because of the information revolution character—which went much deeper than he ever stable. Uproar was their only music. wrought by the Internet. This situation makes had realized—and redoubled his effort to work Like nearly everyone who has thought management harder and more challenging than out the full complexity of capitalism as an deeply about capitalism, Schumpeter came it's ever been before. As a historian, I don't say economic, cultural, and social system. away with mixed feelings. He regarded himself that lightly. As for my personal feelings about him, I as a conservative and planned to write a book think Schumpeter is one of those historical on the meaning of conservatism. But, as he told Q: Schumpeter was a fascinating figures that anyone would love to have dinner his fellow economist John Kenneth Galbraith, personality—a womanizer, incredible with, as many people have said of Benjamin “I am pretty sure that no conservative I have intellect, great teacher. And how many Franklin. He was just so witty, knowledgeable, ever met would recognize himself in the picture prominent economists have provoked a and downright interesting that you couldn't I am going to draw.” Schumpeter abhorred sword fight with a librarian? But at the same come away without feeling enriched. Weaving some of the banalities of business culture and time, as your biography illustrates, together the fascinating story of his life with an revered the artistic attainments of the Old Schumpeter could sink into self-doubt. What interpretation of his great body of work made World. He knew that creative destruction are your personal feelings toward the man? the writing of my book not only a challenge, but fosters economic growth but also that it Did your impressions of him change while also a tremendous pleasure. undercuts cherished human values. He saw that writing the book? poverty brings misery but also that prosperity A: One of the joys of writing this book was cannot assure piece of mind. 6 dealing with Schumpeter's personal life. I knew A steep rise in living standards would seem it was going to be interesting, but not nearly so Prologue: Who He Was and to be a prize of supreme value for any society. much as it turned out to be. His student Paul What He Did Yet capitalism has a dreadful reputation for Samuelson, the first American to win the Nobel by Thomas McCraw robbing the poor to profit the rich, and it has Prize in Economics, once said that Schumpeter Questions about capitalism—what it is, how never achieved what most people regard as a was great as both a scholar and a personality, and why it has worked well in some places and fair distribution of its bounties. In some but that his comparative advantage may have not others—are among the most important that countries it still represents a curse to be resisted been greater as a personality. I don't quite agree, people and governments have faced. This has and overcome. Even its fortunate beneficiaries but there's no denying his personal appeal, been true for about three hundred years, and in rich countries often have a guilty feeling that especially to women and to scholars and seldom more so than in the present and the capitalism is an unworthy pursuit—something students of both sexes. recent past. Recall the turbulent transition from to be accepted but not celebrated. As The duel you mention, by the way, was over the last decade of the twentieth century to the Schumpeter himself put it, “The stock exchange students' access to books. Schumpeter had

is a poor substitute for the Holy Grail.”7 means of production … second, production for hand. In the absence of credit, both consumers He applied his immense energy to analyzing private account, i.e., production by private and entrepreneurs would suffer endless and explaining capitalist innovation not only for initiative for private profit.” He went on to say frustrations. other experts but sometimes for the that a third element is “so essential to the Reprinted by permission of Harvard nonspecialist. From the compelling story of his functioning of the capitalist system” that it must University Press from Prophet of Innovation: life and work, a reader can grasp the basic be added to the other two.8 Joseph Schumpeter and Creative Destruction mechanism of the capitalist engine about as This third element is the creation of credit. by Thomas K. McCraw. Copyright 2007 by the well as from a whole shelf of textbooks. The The core ethos of capitalism looks constantly President and Fellows of Harvard College. All subject is momentous, and its full social ahead and relies on credit and launching new rights reserved. mechanism quite intricate. But its economic ventures. From the Latin root credo—“I 6. Schumpeter to Galbraith, October 28, essence is not very complicated. As Schumpeter believe”—credit represents a wager on a better 1948, in Hedtke and Swedberg, eds; Briefe, p. himself wrote in 1946, at the beginning of his future. The entrepreneurs and consumers who 366. long article on capitalism for the Encyclopaedia make these bets often care little about the past 7. Schumpeter, Capitalism, Socialism and Britannica, “A society is called capitalist if it and have scant patience with the present. They Democracy, p. 137. entrusts its economic process to the guidance of undertake innovative projects and make 8. Schumpeter, “Capitalism,” the private businessman. This may be said to expensive purchases (houses, for example) that Encyclopaedia Britannica (New York: imply, first, private ownership of nonpersonal require far greater resources than those lying at Encyclopaedia Britannica, 1946), VI, p. 801.