In praise of Schumpeter

Brad de Long has written a thoughtful review of Thomas McCraw’s biography of Joseph Schumpeter. If Ricardo and Marx were the economists of the 19th century, he says, and Keynes the economist for the 20th, then Schumpeter is the man for the 21st.

That missing reign was Schumpeter’s, for he had insights into the nature of markets and growth that escaped other observers. It is in that sense that the late 20th and early 21st centuries in economics ought to have been his: He asked the right questions for our era.

He asked those questions in a book he wrote while working at the University of Czernowitz in his mid-20s: the Theory of Economic Development. Previous first-rank economists (with the partial exception of Marx) had concentrated on situations of equilibrium. In that model, development is a gradual process, in which competition keeps goods high-quality and affordable, and the abstemious owners of capital await the long-term rewards of deferred gratification.

Schumpeter pointed out that that wasn’t how market economies really worked. The essence of capitalist economies was, as Marx had recognized before him, the entrepreneur and the innovator: the risk taker who sets in motion new and more-efficient ways of making old or new products, and so produces an economy in constant change. Marx saw that the coming of capitalist economies destroyed all feudal, traditional, and patriarchal relationships and orders. Schumpeter saw farther: that market capitalism destroys its own earlier generations. There is, he wrote, a constant “process of industrial mutation — if I may use that biological term — that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in, and what every capitalist concern has got to live in.”

Schumpeter saw entrepreneurs not as inventors, but as innovators. The innovator, writes Brad,

shows that a product, a process, or a mode of organization can be efficient and profitable, and that elevates the entire economy. But it also destroys those organizations and people who suddenly find their technologies and routines outmoded and unprofitable. There is, Schumpeter was certain, no way of avoiding this: Capitalism cannot progress without creating short-term losers alongside its short- and long-term winners: “Without innovations, no entrepreneurs; without entrepreneurial achievement, no capitalist … propulsion. The atmosphere of industrial revolutions … is the only one in which capitalism can survive.”

I’ve often thought about that as I listen to the bleating of music executives and their lawyers about the impact of the Net on their business models. In their different ways, Steve Jobs and Shawn Fanning are Schumpeterian entrepreneurs.