TheDruckerVision:Corporations,Managers,Markets,andInnovation

RichardSmith
UniversityofCaliforniaRiverside richard.smith@ucr.edu

June2009 Abstract

This is the second of two essays on the influences of Peter Druckers exposure to proponents of the Austrian School of economics on his writing and philosophical views. In the first essay, On the Foundations of the Drucker Vision, I review the major influences that appear to have shaped much of his thinking, focusing mainly on post-World War I European history and the development of the Austrian School. In this essay, I review Druckers writing with the objective of tracing the how his views have been shaped by these influences. I focus, in particular on Druckers views of classical economics, the profit motive, corporate purpose, the value imperative, corporate social responsibility, managerial ethics, corporate purpose, innovation, pension funds, and the market for corporate control. The over-arching objective of both essays is to provide clearer interpretation of the meaning of some of Druckers most important and frequently misunderstood contributions.

Keywords:PeterDrucker,theAustrianSchool,Schumpeter

JELCodes:B00,B25,B29,B31,N44 CorrespondingAuthor:
RichardSmith A.GaryAndersonGraduateSchoolofManagement UniversityofCaliforniaRiverside 900UniversityAvenue Riverside,CA92521 richard.smith@ucr.edu 9518273554 I am grateful to my former colleagues at the Drucker Graduate School of Management for having provided me the opportunity to study the intellectual contributions of Peter Drucker, and to Drucker, himself, for the many times when speaking with him and hearing his remarks provoked my interest in gaining a deeper understanding of his thinking.

Electronic copy available at: http://ssrn.com/abstract=1459512

TheDruckerVision:Corporations,Managers,Markets,andInnovation
Over his prolific live, Drucker has written enough and on so many topics that it is possible to

invoke passages of his writing to apparently support almost any position. Often he is quoted for the proposition that management has responsibility to a broad set of stakeholders a social and ethical responsibilitythattranscendstheclassicaleconomicnotionofprofitmaximizationandwheresurvivalof the enterprise, per se, has intrinsic value. But are these accurate characterizations of what Drucker sees asthelegitimateresponsibilityofmanagement? Of course, understanding what Drucker meant is of direct interest as a means of limiting the

potential for the power of his written words to distort the evolution of the dialog. My thesis is that Druckers vision and his management principles derive from his uncompromising application of Austrian School economic principles, tempered by a broad grasp of history and by his exposure, early in his life, to aparticularlyturbulentsequenceofsocioeconomicevents. Druckers views are interdependent, but some of the more central themes can be organized, underfourheadings: Classicaleconomicsandtheprofitmotive, Corporatepurposeandthevalueimperative, Corporatesocialresponsibilityandmanagerialethics, Corporatepurposeandinnovation.

In sections I through V, I review the themes in Druckers writing and related them to the historical and economicfoundationsofhisvision.SectionVIdrawsuponthewaysinwhichhistoryandeconomicshave influenced Druckers vision to offer some conjectures as to how he might have viewed the financial and economic crisis of 200809. The historical and economic foundations of the Drucker vision are reviewed inarelatedessay,OntheFoundationsoftheDruckerVision. I. ClassicalEconomicsandtheProfitMotive

Electronic copy available at: http://ssrn.com/abstract=1459512

OnKeynesianMacroeconomics Throughout his life, consistent with the Austrian School view, Drucker was critical of economic

models that were overly mathematical and dismissive of the role of the individual. Keynes was a particularandrecurringtarget.In1946,Druckerwrote, Keynes work was built on the realization that the fundamental assumptions of nineteenthcentury laissezfaire economicson longerhold true in an industrial society . Butitaimedattherestorationandpreservationofthebasicinstitutionsofnineteenth century laissezfaire politics; above all at the preservation of the autonomy and automatism of the market. The two could no longer be brought together in a rational system; Keyness politics are magic spells, formulae, and incantations, to make the admittedlyirrationalbehaverationally.1 In conceding the view that laissezfaire economics does not function in an industrialized society, Drucker accepts that the propensity of the economy to restore full employment through price adjustments may not hold when the economic actors are large industrial firms, labor unions, and others, who are bound through longterm contracts. He claims that policy instruments merely create the illusion of rational behavior. Thus, it does not make sense to stimulate the economy by artificially increasing demand for labor or tricking people into working by inflating the money supply. While he argues against the Keynesiansolution,hedoesnotargueformoregovernmentintervention. OntheProfitMotive As of 1950, Drucker regarded economic performance as the overriding social responsibility of an

enterprise. In any society the first and overriding social function and responsibility of the enterprise is economic performance. Similarly, the enterprises survival depends on

economicperformance.Thedemandsofeconomicperformancewhichsocietymakeson theenterpriseareidenticaltothedemandoftheenterprisesselfinterest:theavoidance of loss There is no conflict between the social purpose and the survival interest of the enterprise.Botharemeasuredatoneandthesametimeonthesameyardstick.2 Here, Drucker is acknowledging that a business that is profitable is doing what society demands.

Hedoessowithoutsuperimposinganynormativejudgmentaboutvaluesdifferentfromprices.Abusiness that is not profitable is wasting resources relative to what society demands. While there may be reasons to suppress the price mechanism, Drucker holds that it is not the responsibility of business leaders to makesuchchoices.This,again,isexactlytheAustrianview. Profit serves three purposes. It measures the net effectiveness and soundness of a businesss efforts It is the risk premium that covers the cost of staying in business Finally,profitinsuresthesupplyoffuturecapitalforinnovationandexpansion3 Thus, in 1954, Drucker accepts the role of prices in directing activity and the role of profit in Druckersviewofprofitderivesdirectlyfromeconomicprinciples.

directing resource allocation. In describing profit as the risk premium that covers the cost of staying in business, Drucker articulates the Austrian School view (in direct challenge to Marx), that profit is the returntocapital.InAustrianterms,profitcompensatesthosewhoalreadypaidforthelaborservicesthat areembeddedincapital.Whenhesaysthatprofitinsuresthesupplyofcapitalforinnovation,Druckeris voicingSchumpeterspremisethatcapitalisessentialforinnovationandeconomicgrowth. Whenever Drucker speaks of business purpose, he does so in a social welfare context and

always means the creation of value for society. Profit (i.e., economic profit) is what validates that the businessisachievingitssocialobjective.

Business enterprises and publicservice institutions are organs of society. They do notexistfortheirownsake,buttofulfillaspecificsocialpurposeandtosatisfyaspecific needofasociety,acommunity,orindividuals.Theyarenotendsbutmeans Butonlybusinesshaseconomicperformanceasitsspecificmission;itisthedefinition of a business that it exists for the sake of economic performance. In business enterprise, economic performance is the rationale and purpose.Business management mustalwaysputeconomicperformancefirst.Abusinessmanagementhasfailedifit does not produce economic results. It has failed if it does not supply goods and services desired by the consumer at a price the consumer is willing to pay. It has failed if it does not improve, or at least maintain, the wealthproducing capacity of the economic resourcesentrustedtoit.Andthismeansresponsibilityforprofitability.4 In1946,Druckeracknowledgestheprofitmotiveasmechanismforsocialefficiency. the profit motive has a very high, if not the highest, social efficiency. All the other known forms in which the lust for power can be expressed, offer satisfaction by giving the ambitious man direct power and domination over his fellow men. The profit motive alonegivesfulfillmentthroughpoweroverthings.5 The profit motive is core to Austrian School reasoning about the importance of prices as a mechanism for allocating resources. Unless people are focused on profits, prices cannot direct human activity. Druckers antipathy for other means of pursuing social efficiency is a reference to central planning, which the Austrians criticize as unworkable. Drucker has seen, first hand, the consequences of failedattemptsatcentralplanning.

But his respect for the profit motive in practice gives rise to a tension with his disdain for formal

economics. In classical economics, the profits drive an economy toward efficient use of resources. Druckerdisagrees,andevenquestionstheveryexistenceoftheprofitmotiveasatheoreticalconstruct. Whether there is such a thing as a profit motive at all is highly doubtful. The idea was invented by the classical economists to explain the economic reality that their theory of static equilibrium could not explain. . The profit motive and its offspring maximization of profits are just as irrelevant to the function of a business, the purpose of a business, andthejobofmanagingabusiness.Infact,theconceptisworsethanirrelevant:itdoes harm.6 The contradiction between this 1974 view and his earlier view is only apparent. In the first, his focus is on the behavior of individuals. In the second, he uses the term more narrowly as equating marginalcostandmarginalrevenue. DruckersreferencetothetheoryofstaticequilibriumandtheprofitmotiveispureSchumpeter. Schumpeterarguedthat,becausethereisnoinnovationintheclassicalmodel,classicaleconomicscannot explain growth or business cycles. Without innovation or other exogenous shocks, there is nothing to disturb the equilibrium. Drucker believes the neoclassical concept does harm because it takes the focus off of innovation. In taking this position, Drucker reiterates the view of Schumpeter in his creative destructionparadigm. Druckers views on profit are easy to misinterpret because he draws subtle distinctions between

profitasameasureofperformanceandprofitmaximizationasabehavioralorientation.Druckersaythat the root of confusion about business purpose is the mistaken belief that the profit motive is a guide to rightaction. Theconceptofprofitmaximizationismeaningless.Thedangerintheconceptisthat it makes profitability appear a myth. Profit and profitability are, however, crucial for

societyevenmorethanfortheindividualbusiness.Yetprofitabilityisnotthepurposeof, but a limiting factor on business enterprise and business activity. Profit is not the explanation, cause, or rationale of business behavior and business decisions, but rather their validity The root of the confusion is the mistaken belief that the motive of a person the socalled profit motive of the businessman is an explanation of his behaviororhisguidetorightaction.7 This emphasis on human behavior rather than abstract principles like profit maximization is at

the core of Austrian School economics. Some people read Drucker do not interpret his comments on profit maximization in this way. Rather, there is a tendency to interpret him as supporting stakeholder valuerelativetoshareholdervalue.Whathemeans,however,isonadifferentlevel.Itisconsistentwith stakeholdervalue,butnotwithinterpretationsofstakeholdervaluethatimplymanagerscanlegitimately make tradeoffs among stakeholder groups. In fact, Drucker argues that the emphasis on profit maximizationleadstomisunderstandingabouttheroleofprofit,andtobadpublicpolicy. It [the profit motive] is a major cause of the misunderstanding of the nature of profit in our society and of the deepseated hostility to profit, which are among the most dangerous diseases of an industrial society. It is largely responsible for the worst mistakes of public policy . which is squarely based on the failure to understand the nature, function, and purpose of business enterprise. And it is in large part responsible for the prevailing belief that there is an inherent contradiction between profit and a companys ability to make a social contribution. Actually, a company can make a social contributiononlyifitishighlyprofitable.8 This position is shaped by his experience with the repercussions of the Industrial Revolution, all

the way through the New Deal. If the public believes that shareholders profit at the expense of employees,theywillfighttoeliminatetheprofits.Policymistakes(suchaspricecontrolsandartificialjob

creationprograms)deprivebusinessofwhatDrucker(andSchumpeter)believesaretheresourcestofund realeconomicgrowth. There is only one valid definition of business purpose: to create a customer. It is the customerwhodetermineswhatabusinessis.Itisthecustomeralonewhosewillingness topayforagoodconvertseconomicresourcesintowealth,thingsintogoods.9 Implicitly, his reference to willingness to pay is an allusion to social value creation by selling Here,isDruckersfamouslinethatthepurposeofbusinessistocreateacustomer.

products for more than they cost to make. His use of the word create because a business cannot take its customers as given and simply continue to do the same thing. Rather, consistent with Schumpeter, it mustcreatethecustomerbyinnovating. AnothersubtletythatiseasytomisconstrueisDruckersdistinctionbetweenprofitmaximization

andprofitsufficiency. Profit is needed to pay for attainment of the objectives of the business. Profit is a condition of survival. It is the cost of the future, the cost of staying in business. A businessthatobtainsenoughprofittosatisfyitsobjectiveshasameansofsurvival. A business that falls short is a marginal and endangered business. Profit planning is necessary. But it is planning for a needed minimum profitability rather than that meaningless shibboleth profit maximization. The minimum needed may well turn out to be a good deal higher than the profit goals of many companies, let alone their actual profitresults.10 The apparent conflict is easily resolved when Drucker points out that minimum profitability may

behigherthantheprofitgoalsofmanycompanies.Onecanbestunderstandthisfinalpartofthepassage by keeping in mind Schumpeters notion of dynamic competition. Minimum necessary profitability does

notmeanthatonceafirmachievesthis,itcandowhatitwantswiththerest.Theminimummustinclude a normal return on capital, and while a firm may temporarily achieve a high return, it will not be sustainableunlessitcontinuestoinnovatesuccessfully. II. CorporateSocialPurposeandtheValueImperative Schumpeter expected capitalism to fail due to the inability of democratic processes to restrain

using monetary and fiscal policy to create short run benefits and because an increasingly wealth electorate would favor social programs that would undermine the entrepreneurial spirit. In the face of the high inflation rates of the 1970s and the OPEC oil shocks, the influence of Schumpeters thinking on Druckersvisionisclear. Schumpeter quit, convinced that stopping inflation is a matter of political will rather than of economic theory or policy, but also deeply skeptical about the ability of a free society to take the politically necessary decisions. His pessimistic conclusion, which predicted that democracy would ultimately be destroyed by its inability to forego or to stopinflationbecauseofthelackofpoliticalwillapredictionthatalassoundsfarmore prophetic today than it did in 1946 was squarely based on his traumatic experience as HemmessuccessorinchargeofAustrianfinancesin1922...11 EarlyViewsonthePlantCommunity In his early writings, Drucker looked to the corporation as a solution to Schumpeters

prediction. He argued that business needed to create a sense of community within the firm (the plant community) to curtail the conflict between labor and investors. In 1946, Drucker argued that every member of an enterprise must be seen as equally necessary and afforded equal opportunities for advancement. Like every other institution which coordinates human effort to a social end, the corporationmustbeorganizedonhierarchicallines.Butalsoeverybodyfromthebossto

thesweepermustbeseenasequallynecessarytothesuccessofthecommonenterprise. At the same time the large corporation must offer equal opportunities for advancement.12 Drucker seems to be recalling the dehumanizing conditions and catastrophic consequences of

the Industrial Revolution. The appeal to mutual respect and equal opportunity reflects a concern with polarization of society around the misperception that labor is not a stakeholder in a capitalist regime. Moreover,in1950,Druckerespousestheviewthatitisimportantforworkerstobelieveintherationality andpredictabilityoftheforcesthatcontroltheirjobs. Insecurity leads to a search for scapegoats and culprits Only if we restore the workers belief in the rationality and predictability of the forces that control his job, can weexpectanypoliciesintheindustrialenterprisetobeeffective.13 ThiswritingfollowedtheresurgenceoflaborunrestinthepostWWIIera.1946wasthelargest

waveoflaborstrikesinUShistory.Byscapegoatsandculprits,Druckermeansmanagersandcapitalists. He seems to have sought to foster a mentality, where workers cannot benefit unless business is profitable. His concerns about adversarial relationships between workers and business are natural extensionsofhisexperience. LaterViewsonthePlantCommunityandtheNewSociety The plant community was essentially the model that was used in post WWII Japan, as

championed by Drucker and Deming. The model worked well as long as Japan had an absolute cost advantage relative to the West, and was supplying products without competition from other countries with lower labor cost. Once competition intensified, many firms in Japan found themselves unable to adhere to the organic model of the firm with lifetime employment and internal promotion. Confronted, inthe1990s,withthisreality,Druckerlookedforothermeansofindividualfulfillment.

FiftyyearsagoIbelievedtheplantcommunitywouldbethesuccessorofthecommunity ofyesterday.Iwastotallywrong.WeprovedtotallyincapableeveninJapan.14 I argued then that the large business enterprise would have to be the community in which the individual would find status and function. This, however, has not worked The right answer to the question Who takes care of the social challenges of the knowledge society? is neither the government nor the employing organization. The answerisaseparateandnewsocialsector.15 Istillstronglymaintainthattheemployeehastobegiventhemaximumofresponsibility andselfcontrolButindividualsneedanadditionalsphereofsociallife.16 Not daunted by having been wrong about a central tenant of his early work, Druckers

overarching concern remained how do we avoid the divisive impacts of economic change that were so traumaticinthefirsthalfofthe20thcentury?Whentheplantcommunitymodelprovednottobeableto withstandcompetitivepressurefromotherswhoweremoreinnovative,Druckersoughtsolutionsinother dimensionshisnotionofengagementinthesocialsector. OnStakeholderValue Regarding responsibility to society, Drucker sees the society as the driver and business purpose

asbeinghighlycircumscribed. Thesocialdimensionisasurvivaldimension.The.businessenterpriseisa creatureof a society and an economy. The enterprise exists only as long as the society and the economybelievethatitdoesanecessary,useful,andproductivejob.17 LaterViewsonPurposeandPerformance

10

In later writing, Drucker seems to equivocate on questions related to corporate purpose and

performance assessment. At least in accounting terms, he sees business as focusing too narrowly on profitandwithtooshortrunofaview. Neither the quantity of output nor the bottom line is by itself an adequate measure of the performance . Market standing, innovation, productivity, development of people, quality,financialresultsallarecrucialtoanorganizationsperformanceandsurvival.18 His use of terms like bottom line in these passages is decidedly different from the notion of

economic profit, which he espouses as the true measure of enterprise success. Accounting profit, in contrast,isshortrunanddoesnotprovideforcapitalcost. We need data on totalfactor productivity. That explains the popularity of economic valueadded analysis. [W]hat we generally call profits, the money left to service equity,isusuallynotprofitatall.Untilabusinessreturnsaprofitthatisgreaterthanits cost of capital, it operates at a loss. The enterprise still returns less to the economy than it devours in resources. Until then, it does not create wealth, it destroys it. By thatmeasurementfewU.S.businesseshavebeenprofitablesinceWorldWarII.19 growth. One may argue (as I have) that the present concentration on creating shareholder valueasthesolemissionofthepubliclyownedbusinessenterpriseistoonarrow.But it has resulted in improvement in these enterprises financial performance beyond anythinganearliergenerationwouldhavethoughtpossibleandwaybeyondwhatthe same enterprises produced when they tried to satisfy multiple objectives, that is, when Ultimately, Drucker comes down squarely behind economic profit as the driver of economic

11

they were being run (as I have to admit I advocated for many years) in the best balanced interests of all the stakeholders, that is, shareholders, employees, customers, plantcommunities,andsoon.20 Druckers view on profit as the measure of whether a business is serving societysneeds evolved

because of his perception that accounting profit is too shortrun and because of the pressures of the corporate control market. However, he is still on board with the shareholder value model (economic profit)astheevidenceoffulfillingsocialpurpose. PensionFundsandtheMarketforCorporateControl During the hostile takeover era of the 1980s, Drucker expressed concern about the increasing

concentrationofequityownershipinpensionfunds,andinthecontrolofinstitutionalassetmanagers. Towhomismanagementaccountable?Andforwhat?Onwhatdoesmanagementbase its power? What gives it legitimacy? These are not economic questions. They are political questions. Yet they underlie the most serious assault on management in its history a far more serious assault than any mounted by Marxists or labor unions: the hostile takeover. What made it possible was the emergence of the employee pension fundsasthecontrollingshareholdersofpubliclyownedcompanies. The pension funds, while legally owners, are economically investors. They have no interest in the enterprise and its welfare. In fact, in the United States at least they are not supposed to consider anything but immediate pecuniary gain. What underlies the takeover bid is the postulate that the enterprises sole function is to provide the largest possible immediate gain to the shareholder. In the absence of any other justification for management and enterprise, the raider prevails and often immediately dismantles or loots the going concern, sacrificing longrange, wealth producingcapacityforshorttermgains.21

12

 The essence of Druckers concern is his perception that institutional investors have a short

horizon and that there is an inconsistency between shortrun and longrun value. Since his prescriptions for management are based on longrun value, significant ownership by shortrun investors threatens his prescriptionthatmanagersfocusonlongrunvaluecreation. III. SocialResponsibilityandEthics

OnResponsibilityforImpacts Druckersviewofcorporatesocialresponsibilityasthepursuitofeconomicvalueisstrained

whenthispursuitiscoupledwiththeproductionofexternalities(impacts). .The third task of management is managing the social impacts and the social responsibilities of the enterprise. None of our institutions exists and is an end in itself. Every one is an organ of society and exists for the sake of society. Free enterprise cannot be justified as being good for business; it can be justified only as being good for society. Business exists to supply goods and services to customers, rather than to supplyjobstoworkersandmanagers,orevendividendstostockholders.22 How the conflict is resolved is not simply a matter of managers weighing stakeholder interests.

While economic value is the yardstick, business does not exist narrowly to provide returns to stockholders. Rather, it must provide returns to stockholders by producing what society values. This is a subtlepoint.Whatthisimpliesformanagementiswherethingsbecomeconfused. One is responsible for ones impacts. The first job of management is, therefore, to identifyandtoanticipateimpacts.Wherevertheimpactcanbeeliminatedbydropping the activity that causes it, that is therefore the best solution. In most cases the activity cannot be eliminated. The ideal approach is to make the elimination of impactsintoaprofitablebusiness.Moreofteneliminatinganimpactmeansincreasing

13

the costs. It therefore becomes a competitive disadvantage unless everybody in the industry accepts the same rule. And this, in most cases, can be done only by regulation. Wheneverabusinesshasdisregardedthelimitationofeconomicperformanceandhas assumedsocialresponsibilitiesthatitcouldnotsupporteconomically,ithassoongotten into trouble. This, to be sure, is a very unpopular position to take. It is much more popular to be progressive. But managers are not being paid to be heroes in the popular press. They are being paid for performance and responsibility. To take on tasksforwhichonelackscompetenceisirresponsiblebehavior.23 Thus, Druckers view of responsibility for managing impacts is highly circumscribed. The only

real issue, if eliminating an impact would be costly, is that eliminating it unilaterally would make the firm noncompetitive.Here,theonlyviablesolutioniscartelizationthroughregulationthatrequireseveryone to stop polluting. Druckers view of limited government clashes at times with his argument here. For example, there are better ways to encourage use of ethanol than by subsidizing farmers and mandating ethanoluse,bothofwhichdistortpricesandobfuscatetheevidenceofwhetherbusinessesareproducing socialvalue. OntheSocialResponsibilityandEthicsofManagers Here, thefocus shifts to managerial responsibility for dealing with social problems. According to

Drucker, the manager is responsible for business success not for activities that detract from it. A managerwhodevotesefforttononbusinessactivitiesistakingresourcesfromthefirmanddistortingthe profitmeasureofthefirmssuccess. The manger who uses a position to become a public figure and to take leadership with respect to social problems is irresponsible and false to his trust. The institutions performance is also societys first need and interest. Society does not stand to gain

14

but to lose if the performance capacity of the institution isdiminished. Performance of its function is the institutions first social responsibility. Unless it discharges its responsibility,itcannotdischargeanythingelse.Abankruptbusinessisunlikelytobea goodneighbor.Norwillitcreatethecapitalfortomorrowsjobsandtheopportunities fortomorrowsworkers. Butwherebusinessisaskedtoassumesocialresponsibilityfortheproblemsorills of society , management needs to think through whether the authority implied by the responsibility is legitimate. Otherwise it is usurpation and irresponsible. Every time the demand is made that business take responsibility for this or that, one should ask, Does business have the authority and should it have it? If business does not then responsibility on the part of business should be treated with grave suspicion. It is not responsibility; it is lust for power. Management must resist responsibility for a social problemthatwouldcompromiseorimpairtheperformancecapacityofitsbusiness.It must resist when the demand goes beyond its own competence. It must resist when responsibilitywouldbeillegitimateauthority.24 Drucker is concerned with management losing focus on its responsibility to society and with the

competency of managers to deal with problems that are beyond their expertise. His concern with legitimacyisshapedbyhisexperienceswithillegitimateuseofpowerinEuropeandtheUS. Countlesssermonshavebeenpreachedontheethicsofbusiness.Mosthavenothing todowithbusinessandlittletodowithethics.Theproblemisoneofmoralvaluesand moral education. But neither is there a separate ethics of business, nor is one needed. All that is needed is to mete out stiff punishments to those who yield to temptation. Druckerseesethicsasimportant,butdoesnotseebusinessinvolvinguniqueethicalchoices.

15

 [m]anagers, we are told, have an ethical responsibility to give their time to community activities, and so on. Such activities should, however, never be forced on them, nor should managers be appraised, rewarded, or promoted according to their participation in voluntary activities. It is the contribution of an individual in his capacity as a neighbor or citizen. And lies outside the managers job and responsibility.25 The Austrian School view, just as with impacts, is that intense competition prevents a business

from adhering to a higher ethical standard than its rivals. In such an environment, only legal restrictions withappropriatepunishmentcanalignbusinessconductwithethicalnorms. IV. CorporatePurposeandInnovation

OntheImportanceofInnovationtotheEnterprise In his first model, Schumpeter saw innovation as resulting is continuous displacement of old

businesses by new ones. He later focused on the businesses are renewing themselves through innovation. Drucker, is attracted to the second view, but also with the aspiration that such innovations willalignwiththeinterestsofemployees. Because its purpose is to create a customer, the business enterprise has two basic functions: marketing and innovation. It is not enough to provide just any economic goodsandservices;itmustprovidebetterandmoreeconomicalones. Sooner or later even the most successful answer to the question, What is our business? becomes obsolete. In asking What is our business? management therefore also needs toadd,Andwhatwillitbe?....

16

 Just as important as the decision on what new and different things to do, is planned, systematic abandonment of the old that no longer conveys satisfaction to the customerorcustomers,nolongermakesasuperiorcontribution.26 Schumpeter,asatheorist,isinterestedinthedislocationscausedbyinnovativeactivity.Drucker,

who is much closer to actual management, sees the economic downturns that derive from innovative waves as problematic. Drucker hopes for a world where the innovative efforts of existing businesses can mitigate the negative impacts of dislocation caused by innovation. If so, then possibly some of the divisivenessthatfollowedtheIndustrialRevolutioncanbeavoided. OntheRoleofProfitinInnovation Drucker,likeSchumpeter,emphasizesthatprofitisessentialtothepursuitofinnovation,but

thatinnovativeactivityisguidedmorebyperceivedopportunitytocreatevaluethanbythepursuitof profit,perse. Schumpeters innovator with his creative destruction is the only theory so far to explainwhythereissomethingwecallprofit.Theclassicaleconomistsverywellknew that their theory did not give any rationale for profit. Indeed, in the equilibrium economics of a closed economic system there is no place for profit. If profit is, however, a genuine cost, and the only way to maintain jobs and to create new ones, then capitalism becomes again a moral system As soon as one shifts to Schumpeters dynamic, growing, moving, changing economy, what is called profit becomesamoralimperative.27 For something as central as profitability, we have no real tools at all to determine how much profitability is necessary. In respect to innovation and, even more, to productivity,wehardlyknowmorethanthatsomethingoughttobedone.28

17

In one of his latest efforts to strike a balance between corporate objectives and individual well

being, Drucker ties economic progress and social wellbeing to the presence of entrepreneurial management in large organizations and attributes differences in growth across nations to differences in theentrepreneurialorientationofmanagement. [W]hat actually happened in the United States and in Germany in the fifty years between 1873 and World War I does not fit the Kondratieff cycle. The first Kondratieff cycle, based on the railway boom, came to an end with the crash of the Vienna Stock Exchange in 1873 . Great Britain and France did then enter a long period during which the new emerging technologies could not create enough jobs to offset the stagnation in the old industries. But this did not happen in the United States or in Germany,norindeedinAustria. What explains their different economic behavior was one factor: the entrepreneur. InGermany,thesinglemostimportanteconomiceventintheyearsbetween1870and 1914 was surely the creation of the Universal Bank. The first of these was founded with the specific mission of finding entrepreneurs, financing entrepreneurs, and forcing uponthemorganized,disciplinedmanagement.IntheUnitedStatestheentrepreneurial bankerssuchasJ.P.MorganinNewYorkplayedasimilarrole.29 . Any existing organization goes down fast if it does not innovate. Conversely, any new organization collapses if it is not managed. Not to innovate is the single largest reason for the decline of existing organizations. Not to know how to manage is the singlelargestreasonforthefailureofnewventure.30 Every institution must build into its daytoday management four entrepreneurial activities that run in parallel. One is the organized abandonment of products, , and so

18

on that are no longer an optimal allocation of resources Then any institution must organize for systematic, continuing improvement Then it has to organize for systematicandcontinuousexploitation,especiallyofitssuccessesAndfinally,ithasto organize systematic innovation, that is, to create the different tomorrow that makes obsoleteandreplaceseventhemostsuccessfulproductsoftoday.31 DrawinguponSchumpeter,Druckerrecognizesthatcreativedestructioneventuallywillmakethe

current business of the enterprise obsolete. Based on Schumpeters second model of entrepreneurial activitywhereimportantinnovationstendtooccurwithinlargefirmsbecauseoftheiraccesstocapital he emphasizes systematic innovation as part of the responsibility of the business. He credits continuous innovation for enabling firms and economies to avoid the very long economic downturns that were focusedonbySchumpeter. Schumpeter argued that the process of creative destruction is what drives economic growth and prosperity. The economy necessarily goes through periods of rapid growth precipitated by transformational innovation, followed by economic downturns are inevitable during periods when the rate of innovation slows. Drucker accepted Schumpeters view that important innovations were likely to be developed by large corporations that have access to the capital necessary to support the innovative activity. By emphasizing innovation as a responsibility of management, Drucker hoped for a constructive means of dampening economic downturns. He accepted the notion of creative destruction, but still saw the corporation as having survival value if, through innovation, it could mitigate the impact of economic downturnsonitsemployees. V. Recap Drawingoneconomicprinciples,Druckerconcludesthatthesocialresponsibilityofbusinessisto

produce goods and services that are valued by society at more than the costs of the inputs, and that economicprofitisthebestmeasureofwhetherabusinessisachievingwhatsocietydemandsofit.

19

Based on the Austrian Schools praxeological approach, Drucker advances the view that

economic reasoning and predictions of behavior must begin with a focus on the individual rather than withabstractconceptslikeprofitmaximization. Based on economic principles and onhis views of power,authority, andlegitimacy, Drucker take

the position that a business managers purpose is to focus on achieving the profit objectives of the business by creating value for consumers, and not on solving social problems that exist outside the organization.Heemphasizeslegalandpoliticalapproachestodealingwithexternalities. Druckerregardsethicsasacharacteristicofpeople,notofbusinesses.Inthefaceofcompetitive

pressure, a business cannot make ethical choices that involve costs for some stakeholder and gains for othersagainheappealstolawandpenalties. Based on his experience with the disruptions of the postIndustrial Revolution, and not trusting

government to be able to address the problems, Drucker envisioned the possibility of aligning value creation with a culture of belonging. Eventually he was forced to abandon this view, but continued to seek the same objectives through his emphasis on corporate entrepreneurship and his discussions of the newsocialreality. Finally, Drucker sees business commitment to innovation as the important driver of economic

growthandrapidrecoveryfromdislocation. VI. AConjectureonDruckersViewoftheEconomicCollapseof200809. Based on the CaseSchiller Index, U.S. housing values increased by 123% from 2000 through

2006.32 Driving the increase, two U.S. government sponsored enterprises, Fannie Mae and Freddie Mac, alongwithotherinstitutions,aggressivelyexpandedtheavailabilityoffundsforhomemortgageloans.In efforts to reduce their exposure to the housing market risks; primary lenders, investment banks, and insurance companies engaged in a complex array of riskshifting tactics, including securitization of mortgage pools, insurance of credit risk, creation of special purpose entities that would invest in mortgagebackedsecurities,andtheuseofcreditdefaultswaps. The complex arrangements worked as long as housing prices were rising and homeowners

continuedtomaketheirpayments.However,inthetwoyearsfrommid2006throughmid2008,housing

20

values declined by 21% nationally. The declines were enough to more than wipe out the home owners equityinmanymarkets,evenforconformingloans. Faced with rising defaults, the failures of some counterparties to be able to honor their

commitments, and similar repercussions of the decline, some banks were confronted with losses of regulatory capital that forced them to dramatically curtail lending activities. The housing sector declines andthefinancialcontractionofthebankingsectorprecipitatedaglobaleconomicdownturn. Government in the U.S. responded in a variety of ways, including capital infusions for some

financial institutions, purchases underperforming assets to restore banks ability to lend, revisions of marktomarket rules, infusions to support troubled firms in the automobile industry, and aggressive governmentspendingtooffsettheperceivedunwillingnessofconsumerstospend. It is natural to ponder what Peter Drucker would have had to say about the financial and

economic collapse. While conjecture is open to easy criticism, conjecture based on the foundations of history, economics, and Druckers own writings is not fundamentally different from the methodology of economic forecasting. While the forecast is certain to be wrong in its details, but may be helpful as a guidetoaction. It seems likely that Drucker would see the collapse as a failure of both management and

government. Concerning management, he might reiterate his concern that the incentives of managers are too shortrun to align their decisions with the objective of longrun value creation, which would benefit not only shareholders, but also customers and subordinate employees. Concerning government, he might fault policymakers for overreaching in ways that created incentives for the managers of financialfirmstofocustheirlendingdecisionsinwaysthatwouldnotbeeconomicallysustainable. Government, according to Drucker, is best if it is limited to providing an infrastructure of rules and enforcement that can enable economic enterprises to thrive by offering products and services that customers demand. Even though Drucker was frustrated in his search for economic enterprise models that could achieve the harmony of customer service and employee satisfaction, he never proposed that government has a legitimate role in trading off labor market and consumer market interests. In fact,

21

based on his experience with the rise of totalitarianism in Europe, Drucker was fearful of government usurpationofeconomicpower. Based on his critiques of economic models that are not grounded in human behavior, Drucker probablywouldhavebeencriticaloffinancialengineeringmodelsthatwerebasedonstatisticalarbitrage and disconnected from such basic questions as: How much of the economic value of societies capital can reasonably be sustained in the form of investments in housing? How will people respond if housing values decline and mortgage payments are sharply increasing for some? And what will happen to the financial sector if declining housing valuesand rising unemployment lead to significant defaults? Drucker might argue that if the housing market were viewed through the lens of underlying demographics and household consumption and investment choices, rather than the lens of quantitative statistical models, it would not have been difficult to anticipate the housing market decline and to predict its impact on the financialsector. Drucker, as a proponent of the rule of law, did not favor the direct government intervention in thesurvivaloffinancialfirmsorspecificindustrialfirms.Thenotionoftoobigtofailmighthavecarried littleweightwithhim.Aslongastheinterestsofconsumersandcounterpartiescouldbeprotected,there seems to be little merit to the argument that government should become involved in protecting the wealthofthosewhochosetobeartheriskofinvestinginfinancialfirms. It seems likely that Drucker would argue, along the lines of Schumpeter, that some U.S. automobile producers have failed the market test. Nothing suggests that these firms are capable of generating the economic returns that are necessary to compensate investors for continuing to support them. As such, perhaps they should be permitted to fail quickly so that the resources can be redeployed toactivitiesthatsocietyvaluesmorehighly. Based on his experience in Austria, Drucker might be concerned about the growth of government. He might also have challenged the efficacy of the regulatory bodies that were supposed to be preventing the crisis in the first place. The SEC, which pushed for passage of SarbanesOxley after Enron, permitted the same offbalancesheet exposures to default to arise in the financial sector. Mark tomarket accounting, which was championed by regulators in the interest of transparency, actually

22

magnified the impact of the defaults that occurred. Based on his exposure to the Austrian School, Druckermightobservethatparticipantsinthecompetitivemarketswillalwaysfindtheweaknessesofany regulatory infrastructure, so that unintended consequences are inevitable an argument of simplicity in theuseregulationtodirecteconomicactivity. Based on his exposure to Schumpeter and experience with and study of the Great Depression, Drucker would be critical of Keynesianstyle attempts to use government spending to restart economic activity. Government inevitably acts politically, and trying to deal with economic downturns with governmentspendingretardstheincentivesandabilityoftheeconomytorecoverthroughinnovation. Along with Schumpeter, and other leaders of the Austrian School, Drucker might be critical of government efforts to influence the course of innovation through direct involvement in such matters as the environment. While government may provide incentives to help deal with recognized externalities, there is little evidence to indicate that government is very effect as an entrepreneur. In contrast, the venturecapitalindustry,whichatitshighestpoint,investedonlyabout$100billioninasingleyearandis only about 30 years old , is linked to economic enterprises that, as of 2007, accounted for 10% of nongovernmentjobsand17%ofU.S.GDP.33

23

 Peter F. Drucker, The Ecological Vision: Reflections on the American Condition (New Brunswick : TransactionPublishers,1993):119. 2 PeterF.Drucker,TheNewSociety(NewYork:Harper&Row,1962)63. 3 PeterF.Drucker,ThePracticeofManagement(NewYork:Harper,1954):77. 4 PeterF.Drucker,Management,Tasks,Responsibilities,Practices(NewYork:HarperCollins,1974). 5 PeterF.Drucker,TheConceptoftheCorporation(NewYork:NewAmericanLibrary,1964). 6 Ibid.(note4). . 7 Ibid.(note4). 8 Ibid.(note4). 9 Ibid.(note4). 10 Ibid.(note4). 11 PeterF.Drucker,AdventuresofaBystander(NewYork:HarperandRow,1979):28. 12 Ibid(note5). 13 Ibid.(note2,pages200201). 14 PeterF.Drucker,QuotedfromaninterviewinTheBusinessoftheKingdom,1999. 15 PeterF.Drucker,HowKnowledgeWorks,TheAtlanticMonthlyNov1994,75. 16 PeterF.Drucker,PostCapitalistSociety(NewYork:HarperBusiness,1993):4. 17 Ibid.(note4). 18 Peter F. Drucker, The New Realities : In Government And Politics, In Economics And Business, In Society AndWorldView(NewYork:Harper&Row,1989). 19 PeterF.Drucker,ManaginginaTimeofGreatChange(NewYork:TrumanTalleyBooks/Dutton,1995). 20 PeterF.Drucker,TheNewPluralism,LeadertoLeaderFall1999,22. 21 Ibid.(note18). 22 Ibid.(note4). 23 Ibid.(note4). 24 Ibid.(note4).

24

25

Ibid.(note4). Ibid.(note4). PeterF.Drucker,Schumpetervs.Keynes,ForbesMay1983,127. Ibid.(note4).

26

27

53

Peter F. Drucker, Innovation And Entrepreneurship : Practice And Principles (New York : Harper & Row, 1985). 30 Ibid.(note18). 31 PeterF.Drucker,ManagementsNewParadigms,ForbesOctober5,1998,174.

29

Standard and Poor,s, S&P/CaseShiller Home Price Indices 2008, A Year In Review, January 13, 2009, availableat http://www2.standardandpoors.com/spf/pdf/index/CaseShiller_Housing_Whitepaper_YearinReview.pdf. 33 Global Insight (2007), Venture impact: The economic importance of venture capital backed companies totheU.S.economy.

32

25

Bibliography Drucker,PeterF.,AdventuresofaBystander(NewYork:HarperandRow,1979). Drucker,PeterF.,TheConceptoftheCorporation(NewYork:NewAmericanLibrary,1964). Drucker, Peter F., The Ecological Vision: Reflections on the American Condition (New Brunswick : TransactionPublishers,1993). Drucker,PeterF.,HowKnowledgeWorks,TheAtlanticMonthlyNov1994. Drucker, Peter F., Innovation And Entrepreneurship : Practice And Principles (New York : Harper & Row, 1985). Drucker,PeterF.Management,Tasks,Responsibilities,Practices(NewYork:HarperCollins,1974). Drucker,PeterF.,ManagementsNewParadigms,ForbesOctober5,1998. Drucker,PeterF.,ManaginginaTimeofGreatChange(NewYork:TrumanTalleyBooks/Dutton,1995). Drucker,PeterF.,TheNewPluralism,LeadertoLeaderFall1999. Drucker, Peter F., The New Realities : In Government And Politics, In Economics And Business, In Society AndWorldView(NewYork:Harper&Row,1989). Drucker,PeterF.,TheNewSociety(NewYork:Harper&Row,1962). Drucker,PeterF.,ThePracticeofManagement(NewYork:Harper,1954). Drucker,PeterF.,PostCapitalistSociety(NewYork:HarperBusiness,1993). Drucker,PeterF.,QuotedfromaninterviewinTheBusinessoftheKingdom,1999. Drucker,PeterF.,Schumpetervs.Keynes,ForbesMay1983. GlobalInsight(2007),Ventureimpact:Theeconomicimportanceofventurecapitalbackedcompaniesto theU.S.economy,availableat http://www.globalinsight.com/PressRelease/PressReleaseDetail8726.htm Schumpeter,JosephAlois,Capitalism,Socialism,andDemocracy(NewYork:Harper,1950). Schumpeter, Joseph Alois, The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest,andtheBusinessCycle(Cambridge,MA:HarvardUniversityPress,1934). Smith,Richard,OntheFoundationsoftheDruckerVision,thisvolume(McGrawHill:NewYork,2009). Standard and Poors, S&P/CaseShiller Home Price Indices 2008, A Year In Review, January 13, 2009, availableat http://www2.standardandpoors.com/spf/pdf/index/CaseShiller_Housing_Whitepaper_YearinReview.pdf.