Books on the lives of the great economists might not, at first blush, set the blood coursing. Yet Robert Skidelsky’s masterly three-volume biography of John Maynard Keynes proved how engrossing such a life could be. It is high praise to say that Thomas McCraw’s biography of Joseph Schumpeter, Prophet of Innovation, has some of the same quality and appeal. But is Schumpeter really a figure who deserves to be numbered among the great economists?
Leading economists are a bit like academic royalty: They are counselors to our rulers, they have Nobel Prizes to themselves and in Britain the most influential sit in the House of Lords. Keynes and Schumpeter died before either could win a Nobel, but they made up for this by having a far larger impact than most who win the prize. While Keynes’s approach shaped the global postwar economy, Schumpeter’s explained why capitalism could never be tamed by Keynesian regulation. Keynes rarely spoke of capitalism. Schumpeter believed the concept to be essential to true economic understanding. His two most important books were The Theory of Economic Development (1911) and Capitalism, Socialism and Democracy (1942). Schumpeter’s claim to greatness is that he had great insight into capitalism. Despite living and working in Depression-era America, he was utterly convinced that the great crisis was simply a ground-clearing interlude that would usher in the most prodigious wave of growth in human history.
For much of the twentieth century, mainstream social scientists believed the term “capitalism” was unduly loaded and ideological. They spoke instead of “industrial society” and the “mixed economy”–or they saw no need for any label at all. I can still remember the frisson I felt in the late 1970s when I saw a neon sign turning in the Boston night sky reading Capitalism Works. In Europe at this time only the radical left talked about capitalism. Though far from a leftist, Schumpeter shared with the Marxists and the laissez-faire right an interest in capitalism–and a refreshing candor about naming the system. Indeed, influential exponents of these opposed philosophies learned from Schumpeter, with his focus on the importance of the entrepreneur and on a restless, ruthless accumulation process fostering insatiable appetites and limitless capacities. Like those who erected that sign in Boston, Schumpeter believed that capitalism works, or would work if only politicians gave it a chance.
Schumpeter was born in 1883–the same year as Keynes–and lived only four years longer, dying in 1950. He had a Czech mother and German-speaking father but was raised by his mother in Graz and Vienna. Among the latter city’s galaxy of intellectual stars, several–Ludwig von Mises, who would become the co-founder of the free-market school, and the “Austro-Marxists,” headed by Otto Bauer, leader of the Social Democratic Party–were preoccupied by the workings of the market, seen as either a rival or a complement to state bureaucracy. Fear of German power, and of the growing strength of a Marxist labor movement, prompted this Austrian interest in capitalism. A sequence of photographs reproduced in McCraw’s book show the members of the famous Marx seminar at the University of Vienna led by professor Eugen Böhm-Bawerk, a former imperial finance minister and author of Karl Marx and the Close of His System (1899). Schumpeter is flanked by Mises, Bauer and Rudolf Hilferding, the Marxist economist and future German finance minister.
Schumpeter’s Theory of Economic Development conveyed his conviction that entrepreneurship and competition were constant sources of growth and disruption in capitalist economies. While other economists saw competition as focusing on price, Schumpeter argued that the process also embraced the development of new products and processes, with often devastating effects on established producers. This was the germ of what he was later to call “creative destruction,” the wavelike process in which yesterday’s leaders are replaced by those with something radically new to offer, be it the railway, the automobile, the PC or the iPod. Others were so mesmerized by the great trusts, and their apparent power to control the market, that they did not see how vulnerable even the greatest could be if challenged by a new product.
McCraw argues that Schumpeter gives us a keen insight into the world of globalized capitalism, a world built on the ruins of Keynesian-style national economic regulation. Schumpeter sought to explain the behavior of real-life corporations like International Harvester, Bell and Ford. Keynes’s General Theory does not mention a single firm. While others write patronizingly of “widgets” and the “better mouse trap,” Schumpeter sought to chart the dynamics of product innovation.
But if Schumpeter’s work looked forward to the twenty-first century, his early life has an aura of the nineteenth-century fin de siècle and ancien régime. While still in his 20s he won an appointment to a chair in Czernowitz, an eastern outpost of the Austro-Hungarian Empire, where he found that his students were denied proper access to the library. Challenged to a duel by the school’s librarian, he fought to help his students and, not least, to demonstrate his honor–satisfaktionsfähig–as an Austrian gentleman. By virtue of his swordsmanship, Schumpeter drew first blood, and the library’s collection was made fully available to his students. When he moved from Czernowitz to a chair in Graz, Francis Joseph, the 81-year-old emperor, presided over the ceremony. As a servant of the crown, Schumpeter, like all university professors, wore a civil service uniform during his lectures.
Schumpeter spent time in Britain, Cairo and the United States before the outbreak of war in Europe but returned to Austria in 1914 to pursue his academic career. At the war’s close, he was invited by Karl Kautsky to join the “socialisation commission” established by the new Social Democratic German government. Hilferding was also a member and claimed that Schumpeter was far more radical in his proposals than his Marxist colleagues. Later Schumpeter explained that he was curious to see if there really was an alternative to capitalism.
Before long Schumpeter moved back to Vienna, where the Social Democrats offered him the post of finance minister. But he did not last more than four months in the job, stepping down in October 1919. As minister he sought to introduce a swingeing “capital levy”–a steeply progressive tax on capital. His aim was to stabilize the economy, not to expropriate the bourgeoisie. But he arrived too late to avert a crash. McCraw paints a vivid account of the ups and downs of Schumpeter’s early career, but extra tidbits can be gleaned from Wolfgang Stolper’s 1994 biography of Schumpeter. For example, while still finance minister, he offered to raise the funds needed for a “Counter Revolution” in neighboring Hungary, where Béla Kun’s Communists had seized power.
In the early 1920s Schumpeter led a Gatsbyesque existence as Viennese financier and man about town, but he nearly went bankrupt in the second general collapse of 1924. While he comported himself as an aristocrat at the opera and races (as well as on horseback), he married Annie Reisinger, the daughter of the concierge of his swanky apartment on the Ringstrasse. Skillfully drawing on diaries and letters, McCraw gives a poignant account of Schumpeter’s devastation following his wife’s death in childbirth and of his subsequent lengthy affair with his beautiful young housekeeper and secretary, Mia Stöckel.
Following the ruin of his bank, Schumpeter retreated to academia once again, securing chairs first at Bonn and then at Harvard. After a succession of visiting appointments, he eventually moved to Harvard on a full-time basis in 1932. Schumpeter disliked the Nazis and was soon seeking to arrange appointments in the United States for his Jewish and anti-Nazi German friends. But as he later admitted, he gravely underestimated Hitler. He failed to appreciate both the virulence of the Nazi leader’s racial hatreds and the effectiveness of his policies for reviving the German economy by means of rearmament and public works.
During the 1930s Schumpeter worked on a massive study of business cycles but altogether failed to match the timeliness of Keynes’s great campaigns of advocacy. Schumpeter agreed with Keynes that a great injection of demand was required, but he was intensely irritated by the English economist’s apparent belief that capitalism needed some semipermanent “oxygen tent” if it was to flourish. Schumpeter’s study of American economic history convinced him that capitalism’s success depended on mass demand. Capitalism had already transformed the lives of ordinary people and, given the right conditions, it could lift the whole globe into a new cycle of prosperity. However, he believed FDR’s policies did not help. The US obsession with monopoly and animus against “economic royalism” were misplaced, in his view, because the large companies should be encouraged to engage in nonprice competition and devote large R&D budgets to product innovation.
Schumpeter’s work on business cycles was too compendious and complex to have much impact on his colleagues, let alone the general public. But his lively 1942 polemic Capitalism, Socialism and Democracy became a bestseller and brought him renown and respect far outside the ranks of economics departments. It was in this book that he gave definitive expression to “creative destruction” as the animating principle of capitalist competition. While admitting that such competition brings ruin to whole industries and regions, he stressed that the accompanying rise of innovating industries will bring new goods within the reach of working men and women. In a revealing example, he argued that capitalism meant that “factory girls” could now wear “silk stockings,” garments that only queens could afford in previous centuries. (My mother tells me that nylon was replacing silk by this time, a detail that only confirms the argument of the “prophet of innovation.”)
McCraw shows that Schumpeter was, in many ways, a deeply conservative thinker: probusiness, anti-New Deal and anti-welfare. However, in Capitalism, Socialism and Democracy, he at least half-conceals this by appearing to defer to the radical and socialist ideas then thriving in the English-speaking world. Schumpeter starts by declaring that capitalism cannot possibly survive. He claims to be equally convinced that a socialist economic system–despite what its critics say–might be workable and compatible with democracy, though only if it adopts many market mechanisms. McCraw sees an Olympian irony at work as Schumpeter patiently proves to the reader that capitalist collapse will come not from another terrible downswing but rather from an overflowing prosperity that will sap business motivation and encourage irresponsible attempts to tamper with capitalism. Schumpeter predicted–with a prescience matched by no other thinker–that the period 1940-2000 would see US per capita incomes rise by 2 percent a year, just as they had done in the sixty years before 1928.
In Schumpeter’s view this surge of capitalist prosperity would allow for the solution of all social problems but would also undermine the conditions that made it possible. The motivation of the great business families would be eroded, capitalist growth taken for granted and the anticapitalist moralizing of intellectuals indulged. A drift toward socialism would ensue as governments intervened ever more intimately in the capitalist mechanism. Like Friedrich August von Hayek and Mises, Schumpeter believed in the power of capitalism, but he rejected what he saw as their absurd prejudice against the state, capitalism’s necessary handmaiden.
In response to the argument that socialist economies have no reliable mechanism for setting rational prices–the refrain of Hayek and Mises–Schumpeter suggests that the socialists could devise a collectivist economy that makes full use of markets, price signals and even “profit” yet delivers egalitarian and welfare goals. While some of Schumpeter’s arguments are mischievous–socialism, he suggests, would be a good way of controlling the unions–there is no denying that he had a lifelong curiosity about different economic arrangements.
One sign of Schumpeter’s open-mindedness is to be found in the circle of the brilliant young economists he gathered around him. In 1947 the Socialist Club of Boston invited Schumpeter to debate the future of capitalism with one of his former students, Marxist economist Paul Sweezy (later editor of Monthly Review). The chair was taken by Wassily Leontief, and the event was written up by Paul Samuelson (both men later received Nobel Prizes). The Schumpeter circle also included James Tobin, another Nobelist. And notwithstanding his own conservatism, Schumpeter sought to secure appointments for such radical younger economists as Joan Robinson and Nicholas Kaldor. Schumpeter corresponded amiably with Keynes, though each man doubted the achievement of the other.
During and after the war Schumpeter’s work acquired growing prestige. He had produced a new and much revised edition of The Theory of Economic Development in 1931 and a stream of influential articles. He was an enthralling lecturer and a man of wide culture. In 1948 he was elected president of the American Economic Association. Outwardly jovial and ebullient, he was susceptible to despair and depression, only conquering them by throwing himself into his work. In his American exile he offered up prayers of devotion to his dead wife, Annie, and wrote many letters to Mia Stöckel. Although he knew his letters to Stöckel were opened by the German censors, he did not suppress his criticism of the Nazis. Stöckel pleaded with him to bring her to the States, but according to McCraw, Schumpeter didn’t think she would fit in at Harvard. She eventually married a young Serbian political scientist, and in 1942 she and her husband were shot by the Nazis. Schumpeter probably blamed himself for not forestalling this tragic end.
In 1937 Schumpeter married an American economic historian, Elizabeth Boody Firuski, who helped him overcome his continuing private terrors and complete his intellectual projects, especially a massive History of Economic Analysis (edited by her and eventually published in 1954). Though highly respectable and admired by colleagues, Elizabeth and Joseph became, following Pearl Harbor, the targets of a lengthy inquisition at the hands of J. Edgar Hoover. They and their friends and associates were repeatedly interviewed by FBI agents, and their activities were watched. Hoover was, of course, prone to suspect European intellectuals, but what fed his paranoia in this case were the couple’s Japanese connections.
The Schumpeters had made several trips to Japan. Japanese economists greatly esteemed Joseph’s work, translating his books and articles and inviting him to lecture. Elizabeth researched the Japanese economy and argued that Japan’s economic achievements were being greatly underestimated. None of this meant that the Schumpeters backed Japanese imperialism, but they did downplay the strength and ambitions of the Japanese militarists and failed to denounce the Nanking massacre. Joseph also looked with great foreboding on the implications of the US wartime alliance with the Soviet Union. In his view this would give dire scope to a primitive and backward Russian imperialism.
Racial categories appear in Schumpeter’s writings, as they do in those of many other thinkers of the time–his argument in Capitalism, Socialism and Democracy that socialist ideas will lead to admirable results in Sweden but to misery in Russia is premised on the “racial” inheritance of the two peoples. Schumpeter, though striving to express a logic of cultural evolution, stumbles into a Borat-like ethnic contempt for crude yokels and semicriminal “sub-normals.”
The private reflections recorded by the Schumpeters in letters and diaries were very distant from the patriotism and progressivism of the time. McCraw tells us that Joseph’s bêtes noires were “Harvard, Roosevelt and the Soviet Union.” Hoover’s belief that the Schumpeters were agents of Japan or Germany was ludicrous. But as the allies pressed to a triumphant conclusion, Joseph did express sympathy for the German and Japanese peoples and horror at the mass slaughter of civilians in Dresden and Tokyo, Hiroshima and Nagasaki. Joseph still had a house outside Bonn, and his German papers were destroyed in a fire-bomb assault on a residential district in November 1944.
Without doubt Schumpeter is a great economic historian and an essential writer for anyone who wishes to understand capitalism. McCraw, who has written the definitive biography of his subject, supplies many testimonials to Schumpeter’s genius and influence from both his day and our own. (In my view he could have added the debate on the transition from feudalism to capitalism initiated by Paul Sweezy, which drew memorable contributions from Maurice Dobb, Rodney Hilton and Eric Hobsbawm.)
Unlike Keynes, Schumpeter was not good at framing policies to tackle specific situations. His strength lay in working out the implications of a policy over time. He thought that Keynesian-style deficit-spending by itself would eventually lead to inflation and stagnation and that it needed to be accompanied by policies to foster and generalize innovation.
Schumpeter’s ideas were enthusiastically adopted by Japanese economic planners and informed Japan’s extraordinarily successful postwar growth strategy. The capital levy he had vainly sought to apply as finance minister in Austria was successfully used to choke off inflation and cut war profits in occupied Japan. The Japanese strategy of creating markets for new products, with industrial groups investing in R&D and the Ministry of Foreign Trade supplying coordination, echoed and confirmed Schumpeter’s thinking.
Another country whose development path had a Schumpeterian flavor was Sweden. The so-called Rehn-Meidner model put the accent on industrial innovation and full employment as well as generous social provision. Rudolf Meidner, a Social Democrat refugee from Germany who became chief economist of the LO, the main trade union federation, was certainly familiar with the work of Hilferding and Schumpeter. In Sweden large corporations were allowed to build up tax-free reserves so long as they spent them on R&D. Meidner eventually sought to complete the “Swedish home” with social funds raised by means of a share levy, a gentler version of the capital levy. These “wage-earner” funds were terminated in the early 1990s, thwarting Meidner’s aim to promote economic democracy; still, they were used to establish a string of research institutes that have kept Sweden at the forefront of the information economy.
Schumpeter never worked out a rigorous model of his own, and several of the ideas he tossed out were no more than brilliant jeux d’esprit. Among twentieth-century economists, Keynes and Hayek made more considerable contributions. But in the twenty-first century, with the disappearance of command economies and of most restraints on capital, the process of creative destruction has taken on planetary dimensions that would surely have shaken Schumpeter, and that now give added interest to his work. Indeed, the very considerable interest of McCraw’s book derives not only from the story it tells of a life navigating what Eric Hobsbawm has called the “age of extremes” but from the case it makes for seeing Schumpeter as the most farsighted of twentieth-century economists. His focus on capitalism and creative destruction made him the prophet of globalization.
Capitalism, Socialism and Democracy remains well worth reading, although it’s best read against the grain of the underlying argument. The book insures Schumpeter a place alongside two other Austrians who understood the market and its limits–Karl Polanyi, author of The Great Transformation (1944), which insisted on the social embedding of market forces; and Otto Neurath, the Viennese philosopher who, as financial commissioner in the short-lived Bavarian workers’ republic of 1919, became the first public official to insist on the need for carbon rationing. Capitalism, Socialism and Democracy serves as a useful foil for the sort of global prospectus that has been attempted, with such disappointing results, by the likes of Thomas Friedman and Niall Ferguson. Seventy-five years on, Schumpeter’s work is still a better guide to the world we live in than the shallow quips and complacent jingoism they offer.