From the archive

Schumpeter Centenary
In June we published four essays marking the centenary of the birth of Maynard Keynes. A number of readers asked for an article on 1983's other centenarian economist, Joseph Schumpeter. Here it is.
Nov 19th 1983

The centenary of Joseph Schumpeter's birth has not brought forth an avalanche of academic tributes and retrospectives. There is no Schumpeter industry to compare with the one on Keynes. No pop biographies. No "Schumpeter and the Post-Schumpeterians". Yet his academic reputation at the height of his powers was of the same order, and the impact of his analysis continues to be strongly felt. His own aspirations were immodest: to be the greatest lover in Vienna, the best horseman in Europe, and the greatest economist in the world. In his Viennese youth he owned a notable stable of horses. And though only Mr Valry Giscard d'Estaing, as president of France, was unwise enough to hint at a personal league table of economists in nominating his prime minister Mr Raymond Barre as "le meilleur economiste de France", Schumpeter in his prime was undoubtedly there or thereabouts. History is silent on the first point. Although thought of as Austrian (indeed he was Austrian finance minister at one time), Schumpeter was born the son of a textile manufacturer in what is now Czechoslovakia. But he was only four years old when his father died in 1887, and his mother went on to marry a Viennese general, thus providing a launching pad for young Joseph into the society of the capital.

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United Kingdom United States John Maynard Keynes Joseph Schumpeter

He never entirely lost the faintly aristocratic demeanour acquired in late-imperial Austria-Hungary, a feature which added to his charisma in inter-war Harvard. For it was in the United States that he made his lasting reputation as an economist, writing voluminously, for the most part in English, on a wide range of subjects. At Harvard he influenced many generations of students, including Professor Paul Samuelson, whose doctoral dissertation he supervised, and who became an important disseminator of Schumpeter's ideas. The range and spread of his work was startling. He made significant contributions to analytical methodology, emphasising the critical importance of marginal analysis. He evolved a theory of business cycles, pondered what he called "fiscal sociology", and had an overriding vision of the collapse of the capitalist system. It is important to note, and often disregarded, that the depression of the 1930s, which did influence his thinking in other ways, was not central to his thesis of capitalist collapse. Although the seminal work incorporating this vision, "Capitalism, Socialism and Democracy", was published in 1942, his prophecies of doom were first heard in the mid-1920s when there seemed no limits to growth. Schumpeter's analysis of

what he saw as the destructive internal dynamic of capitalism has since exerted a powerful fascination over impressionable minds. Monopoly man A cornerstone of Schumpeter's economic theory is the notion that monopolies assist economic growth. Conventional theory had always argued that monopolies overcharge, underproduce and extract surplus profits. Schumpeter maintained, rather, that monopolies, with their economies of scale and ability to innovate, were in fact the handmaids of growth. The economics profession is still divided on the point. On the one hand, Harberger's trianglein which the surplus profits are supposed to lieis hard to measure and certainly small. Recent research in the United States puts it at no more than half a percent of gross domestic product. On the other, the innovative capacities of multinationals are uncertain. They are regularly accused of suppressing the development of products damaging to their market franchises. Schumpeter's originality lay, however, in the way in which he turned a view of the dynamics of growth into an apocalyptic vision of the end of capitalismone which, in spite of superficial similarities, at bottom owed little or nothing to Marx. In fact, much of his work was a specific repudiation of Marxist theory. He had no truck with the view that the workers would bring the structure crumbling down; the proletariat is noticeably absent from his analysis. And though he saw a form of socialism as the likely next step in the evolution of western political systems, he did not believe that a socialistic state would necessarily be driven by notions of equality; simply that the state would make production decisions. What emerged would be "an order of things which it would merely be a matter of taste or terminology to call socialism or not". Like Marx he was concerned with developing a dynamic theory of the evolution of capitalism, rather than an exact description of the workings of a socialist state. Unlike Marx he saw the erosion and obsolescence of the entrepreneurial function as central to the contradictions of capitalism. The core of Schumpeter's argument is straightforward: Capitalism is a dynamic process of wealth creation and change, driven by technological innovation. But this innovation is necessarily destructive of what has gone before; there blows a "perennial gale of creative destruction". Butand here Schumpeter was seriously at odds with the views of his colleaguesthe innovative process is encouraged by monopoly which, he believed, had come to be "the most powerful engine...of the long-run expansion of total output". Only within monopolistic or quasi-monopolistic structures could the right atmosphere of risk-taking prevail. The concomitant of this is that big, monopolistic corporations will come to dominate economic life. Because of their necessarily bureaucratic structure, however, they will constrain innovation and become open to criticism. Thus, at last, the process turns upon itself. The "critical frame of mind...after having destroyed the moral authority of so many institutions, in the end turns against its own". The modern corporation, "although the product of the capitalist process, socialises the bourgeois mind; it relentlessly narrows the scope of capitalist motivation...(and)...will eventually kill its roots". For Marx, economic forces would come to destroy the political and social superstructure of capitalism. In Schumpeter's world, the process works in reverse. The social justification for capitalism is eroded by growing hostility towards the cultural conditions of an advanced capitalist state. The political foundations are enfeebled as neo-capitalist groupsthe artisans, the petty bourgeoisieare driven out of an economic

system which has no further use for them. This evolving disenchantment is given coherent form by the intellectuals, constantly criticising the state for its importance to rectify the manifest wrongs of the system, a rerun of the trahison des clercs. Prophecy undone Things don't seem to have turned out that way. To be fair, Schumpeter did not offer a set timetable for his Gtterdmmerung. When pushed, he tended to talk vaguely of the next century or so. But his analysis looks less persuasive today. In part because the major multinationalsthe best of them at leasthave managed to pull off the trick of being vast and innovative at the same time. IBM, for example, stays ahead of the field by creating an environment that encourages experiments and risk-taking Schumpeter himself never developed a theory of multinationals' behaviour, believing that they would have little influence on state policy. This can now be seen as a lacuna in his work. There are other weaknesses to which more recent critics draw attention. He assumes one particular development of capitalism. He forecasts, in fact, that the internal dynamic will carry all before it, that nothing will stop or hinder the process of wealth creation before it consumes itself. In the event, the road from 1942 has been rocky, with inflationary upheavals and the creation of rival monopolies among suppliers of labournever a key element in the Schumpeterian world-view. In nearly every capitalist country, moreover, the free market has sat down with the regulators. A new order of controlsnot as irrational as its feudal or aristocratic predecessors but tiresome none the lesshas been established, giving the entrepreneur enough to rail against without turning on his own kind, and altering the character of the dialogue between the state and business. Few would now maintain that the necessary outcome of frustration with the imperfections of capitalism is the advent of state socialism. Even arguing from within the confines of Schumpeter's own ideas, centrally planned socialism today is far more inimical to the critical frame of mind that is the multinational. But this is hard on a man who died in 1950, and the essence of whose theory was first adumbrated 25 years before that. Judgements based solely on the way the world looks at the end of 1983 could be less durable than his own. A similar article in 1969 might have dwelt on his prescience in forecasting intellectual dissent and alienation from Paris to Berkeley. Had he survived that long, there is little doubt that he would have made a more charismatic and coherent guru than Marcuse. There would have been more champagne than cannabis, maybe, but more sense too. Zero-sum state To a present-day reader, the most striking features of Schumpeter's thinking remain its rigour, novelty and clarity. His synthetic skills were outstanding. The breadth of his understanding, the confidence of his grasp of ideology, philosophy and economic method are still thrilling today. There are few economists now writing who would chance their arms so far. All that said, Capitalism, Socialism and Democracy is now a period piece. This is not so of all his writing. Some of his less popular and accessible work speaks directly to current concerns in the United States and western Europe about the size and scope of the public sector. The quality of debate in Britain about public spending cuts could be transformed if ministers (and their opponents) spent a wet weekend with Schumpeter's The Crisis of the Tax State. His central thesis is that there is a natural limit to the expansion of the state into new areas of economic activity. But he then argued that

If the will of the people demands higher and higher public expenditureif more and more power stands behind this will, and if the people are gripped by entirely new ideas about private propertythen the tax state will have run its course and society will have to depend on other motive forces for its economy than self-interestWithout doubt the tax state can collapse.

Politically, the message is ambiguous. It can be read as an exposition of the fundamental weakness of the acquisitive society, and he used a variant of the argumentagain focusing on the withering away of the wealth-creating urgeto explain the inevitable advent of socialism. But his analysis is similar to that of conservative philosophers who argue for the contraction of the state. Schumpeter forecast a relentless growth in the public's demand for governmental services, from basic social provision to intervention in the productive areas of the economy. He saw a finite limit to the state's ability to respond effectively to these demands. As the state sector grows, in the Schumpeterian analysis it reduces the area of entrepreneurial activity and becomes a dampener on the economy, sucking away funds needed for productive growth. Crowding out is the more recent description. The consequence is that the state is soon unable to fulfil the demands on it. Social tension grows as competing claimants on a shrinking pot slug it out in a substitute market-place, peopled by lobbyists, by interest-groups and, eventually, by streetfighters. The argument is familiar today. But people are no nearer to understanding the precise point at which the breakdown will occur. Some argue that Britain came close to it before the election of a Thatcher government in 1979. Others reply that the economy shrank, public spending roseyet society has held together, and even re-elected Mrs Thatcher. Politicians and economists trade statistics on the proportion of GDP accounted for by the state in different western economies. Why, the big spenders ask, is 45% insupportable in Britain while the West Germans get along with a similar, even larger, percentage and churn out economic miracles? Schumpeter believed the answer lay in a close examination of fiscal sociology. He saw taxes as being like club dues, which individuals were willing to chip into a central fund for the general goodthough once taxes exist they become a handle which social powers grip in order to change the structure. The circumstances in which different levels of taxation are agreed or exacted vary enormously from state to state. Only by understanding the tax history of a society can an economist hope to identify the limits to state growth and the tolerance of public-sector interference in the productive economy. Public finances, he said, are one of the best starting points for an investigation of society. This sound advice has been largely ignored by economists. Treatises on the creation of surplus value, the extraction of monopoly profit and the behaviour of stock prices far outnumber those on how the state finances its spending and allocates resources. In his centenary year, Schumpeter's preoccupations can be seen to have been the right ones. Innovation and the scope of public finances remain as central as ever to the successful functioning of the mixed economy. The sources of growth are still opaque; his descriptions of the innovative process have not often been bettered. And most countries await their definitive tax historian. His two interests outside economics, women and horses, also still have their supportersand some would say, remain as dimly understood as the economy.

alf a Century Later, Economist's 'Creative Destruction' Theory Is Apt

for the Internet Age : Schumpeter:The Prophet of Bust and Boom

By Sharon Reier Published: June 10, 2000

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IT IS A COLD, grim June day in London, but 32 brand-new entrepreneurs are generating some heat as they make 10-minute business presentations in a hotel just off Hyde Park. Their audience: Several hundred venture capitalists who have gathered from three continents and paid $1,800 each to identify the next Bill Gates, or at least the next Jeff Bezos. Welcome to the vision of Joseph Schumpeter. Schumpeter was an Austrian-trained economist, economic historian and ardent capitalist who developed a theory with the breadth and grandeur of that of Karl Marx. But where Marx viewed labor as the fundamental unit of economic value and the proletariat as the key agent of change, Schumpeter saw the entrepreneur as the cornerstone of capitalism. Although he died 50 years ago, Schumpeter's theories anticipated an age when an entrepreneur such as Mr. Gates could command as much global recognition as the president of the United States or the latest rock star. "Schumpeter would have understood the Bill Gates story perfectly," said Stanley Metcalfe, director of research at the Center for Research on Innovation and Competition at the University of Manchester, in Manchester, England, and president of the International Schumpeter Society. "He saw the entrepreneur as often facing great hostility." Schumpeter's theory sets forth the idea that the vital force behind capitalism is innovation and the entrepreneur willing to introduce it. A product of the Depression and the economic instabilities that gripped Europe after World War I, Schumpeter also grappled with uncovering the fundamental causes for

the business cycle of booms followed by busts. His thesis was that the introduction of innovations was responsible for both the progress and the instabilities of capitalism. Those instabilities he attributed to the principle of "creative destruction," a process in which new technologies, new kinds of products, new methods of production and new means of distribution make old ones obsolete, forcing existing companies to quickly adapt to a new environment or fail. It is an idea that has been seized upon by economists, including central bankers, to explain the remarkable pace of growth, especially in the United States, and to justify the extraordinary gains in the stock market. If creative destruction allows fast economic growth without generating serious inflation, then it might make sense, for example, to put high values on the shares of companies that will do well in such an unusual environment. It would also behoove governments not to interfere with the prosperity-creating potential of this radical kind of capitalism, even if the destructive elements bring down established companies and lead to job losses. "Today, nobody can speak about the market society without using these words 'entrepreneur' and 'creative destruction,"' said Manfred Prisching, professor of sociology at the University of Graz in Austria and a former Joseph A. Schumpeter fellow at Harvard University. Schumpeter himself taught at both the University of Graz and at Harvard University. His extensive writings display a great understanding of all economists before him, but Mr. Prisching said he had departed from mainstream theory, which viewed capitalism and the market as stable. "Schumpeter believed the static order is disturbed by the entrepreneur, and he investigated where that entrepreneurial spirit came from," Mr. Prisching said. "He saw it as a different way of looking at the world: The will to create an empire for one's self. It is a dynamic force that stems from the disposition of some people. Not that they are particularly intelligent. It is not cognitive ability. They are not subtle people. They are often very crude, but they want to attack the world in a certain way. If you take the old adventurers, capitalism turned that into this calculating spirit." Whatever their nature, entrepreneurs, by advancing new products, technology or production methods, provide an impulse for change and, in Schumpeter's words in his 1942 book, "Capitalism, Socialism and Democracy," "a perennial gale of creative destruction." Although overshadowed by the British economist John Maynard Keynes during his lifetime, Schumpeter's theory and phraseology have become mainstream today for describing the current era, in which neweconomy companies are being created at an astounding rate. No less an establishment figure as Alan

Greenspan, chairman of the U.S. Federal Reserve Board and a Harvard-trained economist, has been using Schumpeterian economics to explain the remarkable noninflationary expansion in the United States over the past eight years. Testifying before the Joint Economic Committee of Congress a year ago, Mr. Greenspan said the "evident acceleration of the process of creative destruction, which has accompanied these expanding innovations and which has been reflected in the shifting of capital from failing technologies into those technologies at the cutting edge, has been remarkable." The innovations Mr. Greenspan was describing included the microprocessor, the laser, fiber optics and satellite technologies. But he added: "The innovations in information technology so called IT have begun to alter the manner in which we do business and create value, often in ways that were not readily foreseeable even five years ago. As this century comes to an end, the defining characteristic of the current wave of technology is the role of information." Nor is the wave of innovation limited to new-economy companies. Mr. Greenspan explained that established industries had been adapting the new technologies to enhance their productivity. "Our century-old motor vehicle industry, for example, has raised output per hour by a dramatic 4.5 percent annually on average in the past two years, compared with a lackluster 1.5 percent on average earlier this decade," he said. "Much the same is true of many mature industries such as steel, textiles and other stalwarts of an earlier age." In these messages, Mr. Greenspan seems to be affirming the answer to a puzzle over which he had brooded several years before. "We do not know," he then stated, "nor do I suspect anyone can know, whether current developments are part of a once-or-twice-in-a-century phenomenon that will carry productivity trends nationally and globally to a new higher track, or whether we are merely observing some unusual variations." The idea of major advances occurring every 50 or 100 years echoes Schumpeter's analysis of economic cycles. He conceived of capitalism's restless history as punctuated by long and short waves. A long upswing is stimulated when a new set of technologies and industries comes into existence. Schumpeter wrote that the boom in the early 19th century had been ignited by the rise of textiles, iron, coal and steam engines. The expansion in the mid-19th century, he said, was related to steel production and the construction of railroads, and the early-20th-century boom was driven by automobiles, electric power and associated products.

Schumpeter often used the example of the railroad as a powerful transforming agent in the economy, opening up opportunities while clearing out old areas of activity and ways of behaving. As railroads spread across the United States and freight rates fell to 2 to 3 cents per ton mile, he noted, the old canal and turnpike system suffered to the point of extinction. On the social front, the railroad companies paved the way for the settlement of the Midwest and West, often building grain elevators and preparing many things for would-be farmers. Schumpeter's booms, however, "contain seeds of their own destruction," said Paul Stoneman, head of the Technological Innovation Research Unit at the University of Warwick in England. "The entrepreneur brings along something new," he said. "That's the source of profit. Others come into the market and whittle the profit away. As they copy, you get more investment. You get changes in investment. You get changes in profit. It starts a speculation cycle. Lots of people speculate on the markets and the market starts to boom. But it has to evaporate." "Eventually," he added, "whatever started the boom, everyone has it. Once everyone has a car, there is only replacement demand. Once everyone has Internet access, they stop buying machines to access them." Defenders of Mr. Gates and Microsoft Corp. like to cite Schumpeter's theories on monopoly. Schumpeter believed there was nothing wrong with monopolies and that they could be more effective purveyors of innovation than many start-ups. "You tend to get a monopoly position because you are very good," Mr. Metcalfe said. "Schumpeter certainly believed that you should judge monopolies by their innovation record, not by whether or not it has monopoly profits." "But the important point is that as long as there are open markets, he sees all monopolies as transient," he added. "Capitalism is restless, and somewhere in California, there is a young kid plotting Bill Gates's downfall." If Schumpeter got something wrong, it was in his vision of capitalism's endgame. He predicted that capitalism would become bureaucratic, squeezing out the individual entrepreneur and making innovation routine and subject to centralized management. So far, the evidence points against this hypothesis. If anything, capitalism and entrepreneurialism are spreading. Even in South Korea, long dominated by huge bureaucratic conglomerates, entrepreneurs and venture capitalists are emerging as heroes.

"There are now about 6,000 official start-ups in South Korea," said Young Han, a member of the Samsung Global Strategist Group, who was attending the entrepreneur's meeting in London in the hope of finding new European firms that Samsung might want to back. "All the young people are crazy about start-up companies. We now have 140 venture-capital companies where we had two dozen a few years ago." Asked Mr. Han: "Do you know who is now one of the heroes in Korea? Masayoshi Son, the CEO of Softbank. His company is in Japan, but his origins are Korean." Schumpeter would no doubt have been delighted.

Heavy Thinker
A review by Robert M. Solow I knew Joseph Schumpeter only in the last five years of his life, from 1945 until his death in 1950, at the age of sixty-six. To say that I knew him is actually a bit of an exaggeration. First as a returning undergraduate and then as a doctoral student in economics at Harvard, I attended his courses on advanced economic theory and the history of economic thought. The theory lectures bordered on incoherent; they alluded to everything but analyzed nothing. He would say: "Of course you know about X or Y, so I do not have to go into detail." But we didn't know about X or Y, as he must have realized. The history lectures were also disappointing. I do not remember where they began, but at the end of the term they had barely reached Adam Smith. The course felt like a stage display of multilingual erudition. More generally, Schumpeter seemed to be playing the role of grand seigneur, and he tended to flatter where flattery was not due, no doubt satirically. All this went along with his reputation as a casual and easy grader. We used to say that he threw the exam books up a staircase: the ones that stuck at the top got an A, the ones that fell to the bottom an A minus. I was surprised to learn that in Austrian universities he had the reputation of a stern taskmaster. You would not gather any of this from Thomas K. McCraw's account of those last years. He records that Schumpeter was troubled by the slow course of his own work, and unhappy about his relations with his departmental colleagues; but he says that Schumpeter was enthusiastic about his teaching and successful at it. McCraw may have been misled because Schumpeter's style was always flamboyant, entertaining, and exotic, and many students enjoyed the spectacle. Maybe it is just as well to slide over Schumpeter's failings at the end. He was past his peak; and the economics profession was moving in a direction -- rigorous theory couched in mathematical terms -- that he had always professed to admire but simply could not practice himself. There is good evidence that earlier cohorts of Harvard students found a slightly younger Schumpeter inspiring and a force for high intellectual standards. In 1940 Schumpeter seriously contemplated leaving Harvard to accept a financially equivalent and organizationally more attractive offer from Yale. His senior colleagues at Harvard -- some able, more of them drab -- sent him a letter urging him to stay; it said the right things, but was perhaps a little perfunctory. A much more urgent, heartfelt, and mind-felt letter was signed by twenty-six junior faculty and advanced graduate

students. The authors included the flower not only of Harvard-trained economists of that time, but of the future of American economics. You have to admire the man who evoked those words from those people. I wish I had known him then. It is to Schumpeter's eternal credit that, at a time when mediocrity often cottoned to mediocrity in Harvard economics, he stood always for intellectual quality and energy, regardless of ideology, ethnicity, or social position. McCraw makes this very clear, and understands its importance. In recollecting Schumpeter, it is hard to tear oneself away from the exotic manner, the dubious politics, the carefully crafted image, the hidden self-doubts, the convoluted life story, the complicated relations to three wives and several non-wives. McCraw covers all these in great and often fascinating detail. He makes full use of Schumpeter's diaries, which is where we learn of his self-doubt; it certainly was not evident in his public manner. On some issues -- in his politics especially -- he tends to give Schumpeter the benefit of the doubt, though not foolishly or blindly. One could have been harsher about Schumpeter's belief that Franklin Roosevelt was aiming at dictatorship, even if there were respectable members of the Union League Club who agreed. Still, what really matters are Schumpeter's writings -- the books and a couple of essays; and that is where I have something to add. I do not fully agree with McCraw's judgments. In my view -- and that of most contemporary economists, I believe -- Schumpeter's most original and most lastingly significant book was Theory of Economic Development, which appeared in 1911 (and was translated into English in 1934). It was at the University of Czernowitz, not far from the beginning of his career as an economist, that he worked out his conception of the entrepreneur, the maker of "new combinations," as the driving force and characteristic figure of the fits-and-starts evolution of the capitalist economy. He was explicit that, while technological innovation was in the long run the most important function of the entrepreneur, organizational innovation in governance, finance, and management was comparable in significance. Innovation is not the same thing as invention. Anyone can invent a new product or a new technique of production. The entrepreneur is the one who first sees its economic viability, bucks the odds, fights or worms his way into the market, and eventually wins or loses. Each win means profit for the entrepreneur and his backers, and it also means a jog upward for the whole economy. In the course of this process, which cannot possibly run smoothly, many businesses, individuals, and institutions, themselves founded on earlier successful innovations, will be undermined and swept away. Schumpeter called this birth-and-death process "creative destruction," and realized before anyone else that it was the main source of economic growth. There is no feasible alternative for capitalism; this is capitalism. Here is a characteristically strong statement: "Without innovations, no entrepreneurs; without entrepreneurial achievement, no capitalist returns and no capitalist propulsion. The atmosphere of industrial revolutions -- of 'progress' -- is the only one in which capitalism can survive." The picture generated by classical and neoclassical economics had none of this dynamism, turbulence, and intrinsic uncertainty. (Malthus was perhaps a partial exception.) Smooth trends and stationary states, equilibria of one kind or another, predominated. There is a sense in which Schumpeter could claim to have been the progenitor of a torrent of modern research that analyzes the dynamics of profit-driven innovation and innovation-driven economic growth. Even creative destruction has been translated into equations. (The pioneers were Philippe Aghion and Peter Howitt, and others have followed.) Schumpeter derived from this analysis a lasting bias in favor of big business. "American opinion is so antibig business," he wrote, "precisely because big business has made the country what it is now and in doing so it has set the standard of the American soul: who is not a part of big business feels he does not meet the standard and by compensation turns against it." Clearly a successful innovation confers, in his view, at least a

temporary monopoly. Without the lure of those monopoly profits, there would be no incentive for anyone to bear the risks of entrepreneurship. Schumpeter believed that large firms were both the source and the result of successful innovation; and so tampering with them would be dangerous. But the issue is more subtle than that. The English economist John Hicks once remarked that "the best of all monopoly profits is a quiet life," meaning that a seller with monopoly power might settle for less than the largest possible profit in order to avoid attracting rivals who would have to be beaten off amid turmoil and uncertainty. There is much evidence that having to compete with best practice is itself an important spur both to innovation and to other aspects of industrial performance. Maybe there is an optimal intensity of competition. I think that this is Schumpeter's main legacy to economics: the role of technological and organizational innovation in driving and shaping the growth trajectory of capitalist economies. Whole subfields of economics now pursue the subject of the care, feeding, and consequences of innovation, using qualitative and quantitative, historical and mathematical methods. McCraw gives only a few pages to Theory of Economic Development. He certainly understands that it is fundamental, but he does not place it as the summathat it is. I agree with him, however, that the two-volume Business Cycles of 1939 was a massive failure, in both senses of the phrase. (I still have the yellowing copy that I bought as a student. It was, and still is, essentially unreadable.) Schumpeter probably intended it as his entry in a competition with Keynes's General Theory, which appeared three years earlier, but it made no visible impression on the profession or the public. The book is full of detail about the rise and fall of firms, technologies, and industries, but it does not rise to the status of a theory of business cycles. It is more like a map on the scale of one foot equals two feet: you see the potholes, but you do not learn much about the scenery. McCraw does not really discuss the main piece of new intellectual machinery that Schumpeter hoped to impose on the jumble of business-cycle history to convert it into a comprehensible tale. That was a system of three oscillations or waves superimposed on one another: a forty-month Kitchin cycle, a roughly ten-year Juglar cycle, and a long Kondratieff cycle of about fifty years. (Kitchin and Juglar were economists of considerable obscurity, and Kondratieff only a little less.) I don't suppose that anyone under the age of eighty remembers any of this, though there remain a few devotees of the Kondratieff cycle. To see six complete cycles, you would have to go back nearly three hundred years. It makes for good stories, maybe too easily. This three-cycle scheme is a pointer to the main theoretical flaw in the book. Schumpeter wanted to place the entrepreneurial innovation process at the heart not only of episodic growth but also of the repetitive "business cycle" (or at least of the two longer species of cycles). McCraw seems to go along. But it does not work. After considerable experimentation, economics has given up on any such periodicities. Whatever was true of the more distant past (when the data were poor anyway), the texts of modern history do not fall into a pattern of regular, repetitive cycles. Instead, "the business cycle" has become shorthand for the series of irregular, shortrun, aggregative fluctuations of varying duration, magnitude, and -- probably -- causation that we call prosperity and recession. Schumpeter had a rise-and-fall mechanism in mind. The monopoly profits collected by a successful entrepreneurial firm attract imitators and competitors, many of which are financed by fresh credit. This activity eventually erodes the initial profits; and then the time is ripe for another innovation, if one comes along. There is obvious truth to this story, but it is far from being a theory of economy-wide fluctuations. Business Cycles was surely a great disappointment to its author. Schumpeter had, essentially single-handedly, written this detailed 1,100-page narrative of events in Britain, Germany, and the United States as seen through

the lens of creative destruction. It must have used up a dreadful amount of even his enormous energy. And the world of economics just kept on arguing about Keynes. In 1942, Schumpeter published Capitalism, Socialism, and Democracy, which was reprinted and translated many times. It was his most successful book by a wide margin, and it is certainly a big canvas. McCraw thinks of it as a landmark of twentieth-century social science, and gives it many pages of description and discussion. I do not think it comes close to being that important; but I have to admit that I have a general distrust of ambitious, overarching attempts to capture a whole socioeconomic system in a few grand generalizations. The book reiterates the standard Schumpeterian vision of capitalist turmoil and transformation, with the entrepreneurs as the indispensable heroes. This time he suggests a mechanism within capitalist society that (inevitably?) causes it to undermine itself. The children and grandchildren of successful entrepreneurs, precisely the people with the right DNA, are seduced by inherited wealth into intellectual pursuits, the arts, aristocratic habits, perhaps even into left-wing or at least anti-capitalist ideologies. It is not the proletariat that blows up the capitalist edifice, which is in fact good for the proletariat. It is the second generation of successful entrepreneurs that lets the ground floor decay. Is this in fact a common pattern? Is it more likely than simple chance would imply? Schumpeter can tell good tales, but it is hard to know if they are the only, or the typical, tales. He also makes the rather paradoxical argument that, with long habit, even the process of innovation itself becomes routinized and depersonalized, and therefore weakened. Can he really have believed that successful capitalism is essentially a romantic virtue? There is little doubt that the heroic view of entrepreneurship came naturally to Schumpeter. Capitalism, Socialism, and Democracy is the kind of swan song that yields willingly to Schumpeter's "vision" without a lot of critical analysis. The chapters on socialism are written almost ironically. Many passages accept, mock-seriously, the benefits in efficiency and equity that have always been claimed for socialism and public-spirited central planning; but then come all the qualifications, Orwellian and worse, often drawn from the experience of the Soviet Union. Saving, for instance, can simply be extracted by the state. "Hardships and abstinence' have been imposed such as in capitalist society could ever have enforced." Under socialism, however, this rigor "presumably will command that moral allegiance which is being increasingly returned to capitalism." Capitalism, Socialism, and Democracy is a well-done polemic from a supremely sophisticated Central European. I don't know if it can be classified 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 not a democrat by instinct or by reflection. He had little confidence in the ability of the average citizen to vote intelligently, or even in his own long-run interest. His book asks if democratic socialism is possible. The conclusion is that perhaps it is possible in principle, but almost surely not in practice. Democratic capitalism is what we have, but democratic resentment and democratic ignorance tend to work against capitalist success, either by accepting socialism or by fostering overregulation. For these reasons, Schumpeter could not conceive that a permanent mixed economy was a viable proposition. He called it "capitalism in an oxygen tent." For him, capitalism is the civilization of a few family fortunes and broad inequality. Democracy, he thought, must turn out to be "laboristic," and therefore inimical to capitalist success. This conclusion was a major error, as McCraw says. It has been soundly contradicted empirically by the sixty years and counting since World War II. Nor was this a mere slip of judgment. Schumpeter's mistake was rooted in his political and social attitudes and even, to some extent, in his characterization of entrepreneurship and the dynamics of capitalism.

As against McCraw, I cannot see this book as a major work of "social economics." My guess is that Schumpeter did not really think so either. (He said as much, but that could have been false modesty.) When the publisher asked for new material for later editions, Schumpeter was content to tack on minor things that he had written about the postwar economy, especially the view that the Soviet Union had been the big winner, having picked the pockets of Churchill and Roosevelt (whom Schumpeter hated anyway). This is not how you treat your life's great work. I will not discuss History of Economic Analysis, edited and published after his death by his wife Elizabeth Boody Schumpeter. It is very long and very recondite. Instead, I think one can learn more about Schumpeter from two books that he did not write. During his prime years, he was episodically working at a book about money. One can see why he might have tried. He had spent some years in private banking, and a shorter unsuccessful interval as minister of finance in Austria. He had published a couple of relevant essays; and Theory of Economic Development emphasizes the creation of credit by the banking system as part of the process by which banks finance would-be entrepreneurs. But he did not have much aptitude for monetary theory, or any important idea to transmit. When the bits he had written down were published as a book in the 1970s, it attracted little attention. Then, in his later years, he thought about writing a treatise that would summarize "Schumpeterian economics." Most especially he contemplated a "preliminary volume" that would summarize the treatise to come, and would tell his story in a style that could reach a broader professional and non-professional audience. This was clearly intended as his answer to Keynes. The internalized rivalry with Keynes, his exact contemporary, for the title of World's Leading Economist seems to have nagged frequently at Schumpeter. But he seemed not to understand what Keynesian economics was about, or why it won over the younger generation. For example, he described Keynes as the apostle of consumer spending (in contrast to his own emphasis on innovational investment). But in fact consumer spending is passive in Keynes's General Theory. The driving force of the aggregate economy is actually investment spending; and Keynes put great causal weight on "animal spirits" and "the state of long-run expectations," both of which are much more akin to entrepreneurial drive. Similarly, Schumpeter charged Keynes with being a "stagnationist" (in contrast to his own belief that there was no natural limit to entrepreneurial energy and innovation). This is a more complicated matter. The Keynesian framework could accommodate stagnationist ideas about the drying-up of profitable investment opportunities; and in other hands it did. Keynes certainly did not admire "money-grubbing," and he would have classified a hot-to-trot Schumpeterian entrepreneur as a money-grubber. That is not stagnationism. It is probably more accurate to say that Keynes erred in a different way, by thinking that consumers might become satiated as their incomes rose and could be left with neither the wish to spend nor the capacity to enjoy leisure. It is possible to see Keynesian and Schumpeterian ideas as complementary. Keynes is about short-run economic fluctuations brought about by erratic variations in the willingness of investors and governments to spend; Schumpeter is about the long-run trajectory driven by the erratic march of technological progress. This complementarity only became clear later, after both men had died, when economic growth became an explicit objective of public policy and topic of systematic analysis. Schumpeter was left frustrated by the younger generation's affinity for his rival. In any case, the "preliminary volume" never materialized. The world turns. Today, some sixty years after their deaths, Schumpeter's star probably outshines Keynes's. The business cycle has receded in importance, partly because the large industrial economies have sprouted a more stable structure, and partly because the lessons that Keynes taught have been learned by central banks and finance ministries. Instead, long-term economic growth has moved to the top of the political and intellectual agenda, and that was Schumpeter's topic. As Robert Lucas memorably put it, once you have begun to think

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

What is creative destruction?

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Peter Baskerville, Wrote the Australian national qualifi...

18 votes by Keshav Choudhary, Gautam Bakshi, John Clover, (more)

Definition Creative Destruction is a paradoxical term introduced to economic theory in 1942 by the Austrian economist Joseph Schumpeter (18831950). He used the term to describe the special form of economic growth that entrepreneurs particularly bring to the capitalist system. Schumpeter argued that it was the entrepreneurs introduction of radical innovation into the capitalist system that was the real force that sustained long-term economic growth, even as it destroyed the economic value of established enterprises who may have previously enjoyed a degree of monopolistic power.

In Schumpeters mind, the net economic benefit from the radical innovation, in spite of the destruction of existing economic value, was greater than if the radical innovation had never been introduced. So, the term creative destruction describes a process of creating net economic growth in the capitalist system where entrepreneurs create more economic value from their radical innovations than is destroyed as their innovation replaces and supplants the established way of doing things. Fundamental to Schumpeter's belief was that The essential point to grasp is that in dealing with capitalism, we are dealing with an evolutionary process

While not happy with his visioned outcome, Schumpeter believed that capitalism would ultimately be destroyed by its

successes and that this creative destruction was just part of the prognosis of capitalisms future. His great defence of capitalism however, was built on the grounds that capitalism sparks entrepreneurship. He was one of the first economists to truly provide us with a clear concept of this term. His theory described the more expanded role of entrepreneurs as innovators not just inventors. He saw that entrepreneurs did far more than just invent as they introduced new means of production, new products, and new forms of organization. These innovations, he argued, take just as much skill and daring as did the process of invention.

Creative destruction and politics Today creative destruction, is almost a throwaway line used by economists to describe the free markets messy way of delivering progress. In his book Capitalism, Socialism, and Democracy (1942), Schumpeter wrote: This process of Creative Destruction is the essential fact about capitalism. In fact he described it as the perennial gale of creative destruction. Schumpeter saw that creative destruction provided a powerful force for making societies wealthier because it made scarce resources more productive as they flowed from the least to the more efficient industries. US house majority leader Dick Armey described Schumpeters theory when he stated "The market must clean itself out by taking resources away from the losers, so it creatively destroys the losing companies and reallocates resources to the winning companies. That's really what's going on."

Schumpeter saw that this creative destruction that caused lost jobs, ruined companies, and vanishing industries was an inherent part of the growth system. He saw that societies that allowed creative destruction to operate grew more productive and richer. While Schumpeter clearly saw that capitalisms pain and gain are inextricably linked, politicians today are not so accommodating of the thought that some individuals (voters) would become worse off, not just in the short term, but perhaps forever.

There are new sirens of protectionism that are singing right around the world as today we face a second Global Economic Crisis. If Schumpeter were alive today he would be arguing that to try and preserve jobs or protect industries that have been creatively destroyed will ultimately lead to stagnation and decline and so short-circuit the march of progress. Creative destruction, while obviously the better course in the economists mind, is never welcomed by those on the destructive side of the paradoxical term. For the disruption of lost jobs and shuttered businesses is immediate, while the payoff from creative destruction comes mainly in the long term. As a result, politicians will always be tempted to block the process of creative destruction by implementing policies to resist this underlying economic change for the better. The ironic point of Schumpeters iconic phrase is this: societies that try to reap the gain of creative destruction without the pain, find themselves enduring the pain but not the gain.

Examples of creative destruction For an historical example of creative destruction you need look no further than in transportation where jobs and industries relating to horses and mules were creatively destroyed by steam powered railways, which were creatively destroyed by automobiles incorporating the internal combustion engine which in some ways have been creatively destroyed by the jet engine airplane.

A more modern example is the way in which the iPod has creatively destroyed the CD. The iPod made listening to music more convenient in that there was a greatly reduced need to carry around replacement batteries, a heavy, bulky CD player or the user's entire CD collection. iPods emergence spurred the decline of CDs and in creating new economic value for the iPod destroyed the economic value of the CD. But on the whole, consumers and societies are now economically better off in satisfying more wants with lesser resources. Another evolving creative destruction that is taking place before our eyes is in news. The immediacy, accessibility and low cost of online news is leading to the declining circulation of newspapers and a reduction in the number of broadcast news viewers. We are witnessing the creative development of a new industry as we watch the destruction of the old.

Maybe the former treasury secretary Lawrence Summers and his ex-deputy Bradford DeLong were right when they observed that "the economy of the future is likely to be 'Schumpeterian'"

Sources http://www.wired.com/wired/archi...

http://www.econlib.org/library/E... http://blogs.vanderbilt.edu/writ...

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Mike Laursen, Software Engineer

1 vote by Keshav Choudhary

I first understood creative destruction by experiencing it at personal level.

My first job in Silicon Valley was working at Xerox, in a division that was formed to try to turn ideas developed at PARC into products. We had very professional, smart team but no matter how hard we worked, none of our projects succeeded commercially. In my estimation, it was primarily because we had poor product management and marketing.

Our division went through several ugly years when we had a layoff every few months. It sucked to have my friends laid off. Even though it was demoralizing, I started to notice that, because of the layoffs, I was developing a network of former coworkers throughout the Valley. Also, virtually all of the people who were laid off found new jobs, most of them where their talents and efforts were part of something more successful.

Sooner or later, many ex-Xeroids ended up at Adobe, a much better run company founded by two guys who left Xerox in frustration.

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John Greathouse, Entrepreneur, Investor, Professor & F...

1 vote by Bankole Makanju

"Creative Destruction" is an excellent example of an academic stating the obvious in obtuse terms. In this case, he wrote a book around the simplistic notion that 'new ideas (institutions/companies/technologies) will destroy old ones'. Wow - that is extremely insightful, thanks Doc.

Take the time you would have spent reading this book and work on enhancing your startup's value prop.

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Venkatesh Rao, civilized person It's a complex idea with a long history in metaphysics, economics and religion. I cant really give a quick answer, but since I was asked to answer, I'll provide a link to my blog post on the subject.

http://www.ribbonfarm.com/2008/0...

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Hyman Braverman, A regular person...

1 vote by Mike Laursen

Way back May 2, 1994 Fortune Magazine had an article By Alan Deutschman about HP and other computer companies... the title: "HOW H-P CONTINUES TO GROW AND GROW Eat your own lunch before someone else does; Hewlett-Packard cannibalizes its winning products by bringing out better, cheaper technologies." HP seemed to have lost its way and Apple and others are eating their lunch. Someone at HP missed the point about the customer.

Does creative destruction happen to countries, not just companies too?

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Martijn Sjoorda, Self-confessed biz nerd since age 14. Now there's a great question! I am afraid that countries as a collective hold on to many patterns, including preservation of what is perceived as national identity, right or wrong, helpful or unhelpful by the very nature of the thing. One of the core objectives of the nation state is the preservation of "self" at almost any cost. This probably explains why it is so damn hard to innovate anything that has the tag "government" and maybe even is a systemic explanation for why the worlds in such a sad overall state. Having said all of that, it could very well be that creative destruction is the ONLY way forward for creating sustainable change in countries. It's early days, but you could qualify some of the Arabic Spring revolutions as well as other non or or low violence revolutionary government changes in the last few years as the dawn of creative destruction as a way forward for regenerating countries.

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Rishabh Tagore, Student No.

Creative destruction is the tendency for radical innovations to cause large scale changes in the economy. For example, how the personal computer replaced type-writers and how e-mail replaced telegrams.

Political answer

The reason creative destruction works is becuase of competition. The PC out-competed the type writer. Competition drives a free-market forward, but countries don't have to compete based on their political system. There is no inherent competition between different political systems as is the case in economies, therefore, creative destruction does not apply.

I am not denying that revolutions will occur in bad regimes, but we do not call that creative destruction. It is not as if a radical new innovation in a political system (there have been very few in human history) completely destroyed another one, causing job losses and social inertia (as is the case with creative destruction).

Sure, a new innovation like democracy may cause people to adopt it, but not because they are out-competed, simply because it is better. If creative destruction did occur in political systems then the entire world have been a fully-functional democracy (or other superior political system) a long, long, time ago. Revolutions occur because people are fed up, not because of competition. Therefore, creative destruction does not apply in this context.

Economic answer

Creative destruction doesn't happen to the entire country because it dosen't really produce anything, individual companies

with-in those countries do, but not the country itself. For example, though a country may mainly export type-writers, the creation of the PC does not destroy the country, but an industry inside of it. Though this may have negative repercussions, the PC does not directly affect the country, as it would a company.

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Anon User No, creative destruction will not put a country out of business, because a national economy bears very little resemblance to a corporation. Creative destruction is about the partial equilibrium in specific markets. It has nothing to do with the general equilibrium issues of a national economy. (However, there are general-equilibrium adjustment frictions in the short run.)