BOOKREVIEW Analyst of Change PROPHET OF INNOVATION: JOSEPH SCHUMPETER paradoxical figure. Now comes Thomas McCraw’s definitive AND CREATIVE DESTRUCTION and elegantly written study to top them all. Drawing upon BY THOMAS K. MCCRAW Schumpeter’s diary, correspondence, early drafts, and CAMBRIDGE, MASS.: HARVARD UNIVERSITY PRESS, 2007 published works, McCraw, a Pulitzer Prize-winning 719 PAGES emeritus professor of Business History at Harvard, paints a vivid picture of Schumpeter’s life and times, his loves and REVIEWED BY THOMAS M. HUMPHREY achievements. Readers will choose their favorite parts of the book. Most enlightening to this reviewer is McCraw’s survey oravian-born, Vienna-educated Professor Joseph of Schumpeter’s scholarly contributions. Ironically, McCraw Alois Schumpeter, who liked to say of his writes that he is “not concerned with Schumpeter’s Maspirations to be the world’s greatest economist, economic thinking, narrowly construed,” but with his “life horseman, and lover that only the second had given and his compulsive drive to understand capitalism.” But that him problems, was a study in contrasts. He relished his fame is a false dichotomy because Schumpeter’s theories cannot as one of the interwar years’ premier economic theorists, yet be divorced from his attempts to come to grips with modestly declined to mention his work in his Harvard capitalism: Each guided and shaped the other. In any case, classes or in his exhaustive book on the history of McCraw provides a perceptive and accurate account of economic thought. (Citations to his work were inserted into Schumpeter’s academic greatest hits and misses. that book by his wife after his death.) An obsessively hard- working, morose (indeed often depressed) writer in private, Greatest Hits he affected a public image of carefree, cheerful ebullience. A Hits include first and foremost the path-breaking notoriously easy grader to his students, he often gave himself and seminal The Theory of Economic Development, published low marks in his diary. A one-time banker, he relied upon the in 1911 when Schumpeter, then 28, was in what he women in his life to balance his checkbook. He chronicled called his scholar’s “sacred third decade” of peak creativity. the evolution of the auto industry but never learned to drive. Other hits followed including the subtle and provocative He admired mathematics but failed to employ them in his Capitalism, Socialism and Democracy, and the mighty work. A harsh critic of the static, steady-state equilibrium History of Economic Analysis, which Schumpeter worked on thinking of the neoclassical marginal utility/marginal produc- throughout the whole decade of the 1940s, and which was tivity school, he nevertheless declared one of its founders, the edited and published by his third wife, Elizabeth, four years French neoclassical equilibrium theorist Leon Walras, the after his death in 1950. greatest economist of all time. Schumpeter pushed one idea all his All of his life Schumpeter champi- life: that capitalism means growth and oned capitalism yet was an expert on growth requires innovation. The book Marx, Marxist economics, and the that put him on the map, entire socialist literature. A Marxist The Theory of Economic Development, economist, Paul Sweezy, was among his states for the first time his vision of closest Harvard friends. He was a polit- capitalism as the economic system ical conservative and antisocialist who that delivers faster growth and higher notwithstanding served as Finance living standards (especially of the Minister for a socialist government in middle- and lower-income classes) post-World War I Austria. He lauded than any other system, albeit in a capitalism’s superior performance disruptive, jerky fashion. Like a while predicting the system’s death perpetual motion machine, capitalism from too much success. He preached generates its own momentum inter- creative destruction — the incessant nally without the need of outside tearing down of old ways of doing force. Even technological change, things by the new — as capitalism’s seen by some as an exogenous propel- inescapable iron law, yet he was unpre- lant, is treated by Schumpeter as pared when his own work fell prey to it. a purely endogenous matter, the The 1990s saw the publication of at product of economically motivated least three biographies of this complex, human ingenuity. 40 Region Focus • Fall 2007 Breaking from received wisdom, Schumpeter replaces observation, Schumpeter effectively abandoned the classical the static equilibrium analysis of his neoclassical dichotomy notion that loan-created money is a mere marginalist predecessors and contemporaries with a sideshow, a neutral veil that together with metallic money dynamic disequilibrium theory of cyclical growth. determines the nominal, or absolute, price level while His key building blocks are profits, entrepreneurs, leaving real economic variables unaffected. Not so, said bank credit creation, and innovation. Profits (supplemented Schumpeter. For him, money and credit are integral to the perhaps with a desire to create a business dynasty) motivate process of real economic growth and so have real effects. entrepreneurs, who, financed by Schumpeter’s most popular bank credit, innovate new goods, hit was his 1942 book Capitalism, new technologies, and new methods Schumpeter preached creative Socialism and Democracy. In it of management and organization. he coins the term “creative These innovations fuel growth and destruction — the incessant destruction” to denote capital- generate cycles. ism’s incessant killing off of the Why cycles? They arise when tearing down of old ways old by the new. The book con- the first successful entrepreneur tains his famous end-of-history overcomes the stubborn resistance of doing things by the new — prediction that capitalism’s of incumbent interests and eases very successes, not its failures the path for other entrepreneurs. as capitalism’s inescapable and contradictions as prophe- The resulting bunching of innova- sied by Karl Marx, will produce tions (not to be confused with iron law, yet he was social forces — the routiniza- mere inventions, which Schumpeter tion and depersonalization of saw as occurring more or less unprepared when his own innovation, the destruction of continuously over time) boosts the image of the entrepreneur investment spending, which bids work fell prey to it. as romantic hero, the creation prices above costs and raises profit of a class of intellectuals hostile margins thereby triggering the to capitalism — which under- upswing or prosperity phase of the cycle. The high profit mine the system and lead to its demise. margins then attract swarms of imitators and would-be If capitalism cannot survive, can one rely upon its succes- competitors into the innovating industries. Output over- sor, socialism, to deliver the goods and amenities of life expands relative to the demand for it, prices fall to or below efficiently and fairly? Yes, said Schumpeter, who proceeded costs thus eliminating profit margins, and the downswing or to provide the supporting argument. Many readers took him recession phase begins. The recession continues, weeding out at his word, but not McCraw. He sees Schumpeter’s inefficient firms as it goes, until the economy absorbs the “defense” of socialism as a devastating satire that mocks the innovations and consolidates the attendant gains thus clearing system instead of bolstering it. Schumpeter, in other words, the ground for a fresh burst of innovation. comes not to praise socialism, but to bury it. In the end, If the upswing has been accompanied with speculative Schumpeter’s case for socialism rests on extremely abstract excesses nonessential to innovation, the downswing may theoretical conditions unlikely to be realized in practice. overshoot the new post-innovation equilibrium. Then the All of which creates a problem: If Schumpeter sought to show cycle enters its depression phase where the excesses are that socialism was a practical impossibility, then why did he expunged and the economy returns via a recovery phase predict its ultimate triumph over capitalism? One wishes that to equilibrium. Schumpeter stressed that the latter two the real Schumpeter would please stand up. phases and the phenomena that generate them are As for democracy, Schumpeter viewed it as a political unnecessary for cyclical growth and could be prevented market in which politicians compete for the votes of the by properly designed policy. It’s not speculative bubbles but electorate just as producers compete for consumers’ dollars in rather the discontinuous clustering of innovations in time markets for goods and services. Always skeptical of plus their diffusion across and assimilation into the econo- consumer rationality, he believed that market power resides my that produces real cycles of prosperity and recession. more with vote seekers than with the electorate, Profits, entrepreneurs, bank credit, innovation — all are whose apathy, ignorance, and lack of foresight enable essential to the growth of per-capita real income in politicians to set the policy agenda and to manipulate Schumpeter’s model. Remove any one and the growth voter preferences. Even so, he felt that capitalism, as long as it process stops. Innovation, for instance, is abortive in the operates within a proper legal framework, is largely absence of bank credit creation necessary to effectuate it. self-regulating and so requires little intervention. It thus Cash-strapped entrepreneurs