Joseph Alois Schumpeter (February 8, 1883 – January 8, 1950) was an economist from Austria and a giant in the history of economic thought. His work initially received little acclaim, the work of his contemporary John Maynard Keynes garnering all the attention. Schumpeter's view of economic health was radically different from that of Keynes, regarding innovation by entrepreneurs and investment into the development of new technologies as the essence of healthy, dynamic disequilibrium. He coined the term "creative destruction" to describe this process of the old being constantly replaced by the new. In fact, he viewed the economy as somewhat like a living organism, constantly growing and changing to maintain its health. He warned that capitalism holds the seeds of its own destruction, and that government control over the economy carries the danger of out of control inflation and economic disaster, both due to the self-centered nature of human beings. Schumpeter's analysis has proved of lasting impact, and has garnered the respect and attention of those involved in economic policy. As humankind advances in maturity, overcoming the selfishness that threatens the life of successful economies and democracy, much of Schumpeter's work continues to inform and support the development of a healthier, prosperous society that satisfies all people.
Joseph Alois Schumpeter was born in Třešť (then part of Austria-Hungary, now in the Czech Republic) on February 8, 1883. He was always a brilliant student and praised by his teachers. He began his career studying law at the University of Vienna under the great Austrian theorist, Eugen von Böhm-Bawerk, taking his Ph.D. in 1906. In 1909, after some study trips, he became a professor of economics and government at the University of Czernowitz (a German-language university in Austria, now in Ukraine), in 1911, at the University of Graz, where he remained until World War I.
In 1919-1920, he served as the Austrian Minister of Finance and, in 1920-1924, as President of the private Biederman Bank which collapsed in 1924, leaving Schumpeter in bankruptcy. From 1925-1932, he held a chair at the University of Bonn, Germany.
In 1932, Schumpeter had to leave central Europe because of the rise of the Nazis and he moved to Harvard University—he had already lectured there in 1927-1928 and 1930—where he taught from 1932 to 1950. During his time at Harvard, he was joined by Wassily Leontief, John Kenneth Galbraith, and fellow Austrian, Gottfried Haberler. There, he taught Paul Samuelson, James Tobin, Abram Bergson, among others.
Schumpeter's bad luck was that he was the contemporary of John Maynard Keynes, the two being born but a few months apart. Hence, his prestige among colleagues seemed a bit outdated and not in touch with then-fashionable Keynesianism.
Although Schumpeter encouraged a number of young mathematical economists and introduced mathematical economics (Schumpeter 1906, 1946) to Harvard University, not to mention being the founding president of the Econometric Society (Schumpeter 1933), Schumpeter was not a mathematician, but rather an economist. He tried instead to integrate sociological understanding into his economic theories (Schumpeter 1919).
From 1945 to 1950, he worked on what is probably his most famous work, History of Economic Analysis, which was published posthumously. He died on January 8, 1950.
Schumpeter's major work and influence in macroeconomic thinking are revealed in the following assessment:
Adam Smith, make room: Joseph Schumpeter has come to Washington. Capital policy chiefs may not yet be wearing Schumpeter ties, but the Harvard economist's ideas are cited by everyone from former Federal Reserve chief Alan Greenspan to the warring parties in the Microsoft antitrust case… Schumpeter argued that capitalism exists in the state of ferment he dubbed "creative destruction," with spurts of innovation destroying established enterprises and yielding new ones. This view seems far more current than Smith's Newtonian notion of an "invisible hand" generating stability in the marketplace (Frank Rose, 2002).
Schumpeter's most popular book in English is probably Capitalism, Socialism, and Democracy. However, after publishing this book in 1942, Schumpeter was overshadowed by the work of John Maynard Keynes, who preached government spending as a way out of the depression.
His term, "creative destruction," denotes the "process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one" (Schumpeter 1942).
Unlike Karl Marx, who predicted capitalism would be overcome by forces outside those within the capitalist system, Schumpeter argued that capitalism would be destroyed through its own success. He described the capitalist society as producing a class of people who benefited from capitalism but were opposed to the ethos of wealth production, saving, and allocating resources to production; in short to that which sustains capitalism.
The Cambridge economist Joan Robinson found that Schumpeter "has little love for socialism, and none at all for socialists. His natural sympathy is all with the heroic age of expanding capitalism." Herself a leading theorist of imperfect competition, Robinson found Schumpeter's analysis of that subject the "most brilliant" part of the book, "his argument blows like a gale through the dreary pedantry of static analysis." Although Schumpeter had little to say about contrary evidence, especially in his argument about the fadeout of capitalism and its replacement by socialism, "The reader is swept along by the freshness, the dash, the impetuosity of Professor Schumpeter's stream of argument." Whether or not the reader was totally convinced, "this book is worth the whole parrot-house of contemporary orthodoxies, right, left, or centre” (Robinson 1943).
Schumpeter emphasized that he was analyzing trends, not engaging in political advocacy. Although he went so far as to say that creative destruction was an essential aspect of capitalism, this view did not negate the Schumpeter's belief that free market capitalism was the best economic system.
Schumpeter's core argument in Capitalism, Socialism, and Democracy is reducible to three major tenets:
Schumpeter lauded "creative destruction"—the term he used to describe how innovative products and processes make older ones obsolete—as the likely result of human progress. Indeed, Schumpeter’s theory is very much applicable to early twenty-first century economy. In celebrating technology, Schumpeter inherently recognized the creative expression of human beings (Schumpeter 1942).
The concept of entrepreneurship cannot be fully understood without Schumpeter's contributions, being probably the first scholar to develop its theories. Schumpeter argued that the innovation and technological change of a nation comes from the entrepreneurs, or wild spirits. He came up with the German word Unternehmergeist, meaning "entrepreneur-spirit." He believed that these individuals are the ones who make things work in the economy of the country.
Later, in the United States, he pointed out that the ones who really move the innovation and economy are the big companies which have the resources and capital to invest in research and development. One can, however, see both arguments as being complementary.
In Schumpeter's theory, Walrasian equilibrium is not adequate to capture the key mechanisms of economic development. Schumpeter also thought that the institution enabling the entrepreneur to purchase the resources needed to realize his or her vision was a well-developed capitalist financial system, including a whole range of institutions for granting credit.
In the theory of business cycles, where he was following neither Leon Walras nor Keynes, Schumpeter starts, in his The Theory of Economic Development (1911), with a treatise of circular flow which, excluding any innovations and innovative activities, leads to a stationary state. The stationary state is, according to Schumpeter, described by Walrasian equilibrium. And the hero of his story, is, in fine Austrian fashion, the entrepreneur (Schumpeter 1939).
A noticed characteristic of Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process (1939) is his attempt to turn business cycle patterns into predictive scientific wave theories borrowed from physics. As Schumpeter wrote, "Barring very few cases in which difficulties arise, it is possible to count off, historically as well as statistically, six Juglars [8-10-year business cycles] to a Kondratieff [50-60 years] and three Kitchins [40 months] to a Juglar—not as an average but in every individual case." Why this was so, he admitted, "is indeed difficult to see" (Schumpeter, 1911).
Schumpeter's vast erudition is apparent in his posthumous History of Economic Analysis (1954), although some of his judgments seem quite idiosyncratic. For instance, Schumpeter thought that the greatest eighteenth century economist was Turgot, not Adam Smith, as many consider. These judgments are partly explained by his opinion that there is one general system of economic analysis, and Léon Walras was the one who found it.
In Schumpeter's treatise, other economists were rated by how much of Walras' theory could be read into them. Schumpeter criticized John Maynard Keynes and David Ricardo for the "Ricardian vice" (Schumpeter 1946). According to Schumpeter, Ricardo and Keynes reasoned in terms of abstract models, where they would freeze all but a few variables. Then they could argue that one caused the other in a simple monotonic fashion. This led to the belief that one could easily deduce policy conclusions directly from a highly abstract theoretical model.
Schumpeter was a supporter of free markets. However, while Adam Smith was concerned with the effects of supply and demand on product price, Schumpeter focused on innovation, rather than price, as the dominant force in the business cycle. In his early analysis, valuing the role of the entrepreneur as the agent of change, and later recognizing the need for large-scale development of new ideas, he predicted that a full-labor economy would tend to lead firms to invest in new technology rather than raise product prices.
He also argued that the family was the fundamental unit of the capitalist economy. Also, Schumpeter did unintentionally recognize the dangers of disassociating human morality from economics when he predicted that capitalism would fall due to the business and government bureaucracy and corruption that can occur in the free market (Schumpeter 1954).
While John Maynard Keynes revolutionized economic thinking by answering the same questions economists before him (David Ricardo, John Stuart Mill, Alfred Marshall, even Karl Marx) had asked with different answers, Schumpeter asked different questions. While Keynes regarded the economy as a closed system, that, when healthy, was in static equilibrium, Schumpeter rejected equilibrium as healthy and regarded innovation as the basis of a healthy economy. For Schumpeter, dynamic disequilibrium is key and the economy is likened to a growing, living organism rather than a machine (Drucker 1983).
Schumpeter had openly derided the "stagnation thesis" introduced in Keynes's General Theory (Schumpeter 1946). This thesis holds that as a country grows richer, investment opportunities shrink but the propensity to save increases; therefore savings and investment balance only at high unemployment.
For Schumpeter, the entrepreneur who moves resources from old, obsolescent technology and the firm that invests in developing new ideas providing new employment, are essential to the health of the economy. But, for Schumpeter, innovation is also "creative destruction," as the new makes obsolete the old.
While Keynes concluded that a permanent equilibrium of full employment and prosperity could be achieved by government control—government spending, the volume of credit, or the money supply—Schumpeter saw government intervention as increasing inflation until capital would be consumed and both capitalism and democracy destroyed. Keynes was famous for his saying "in the long run we are all dead," but it was Schumpeter who saw that short-term measures have long-term impacts. Schumpeter warned that capitalism could destroy itself if those in power looked only to the short-term.
Although not well received when Joseph Schumpeter initially published his work, by the early twenty-first century the tide had changed. He was described as "today’s hottest economist," in a 2000 issue of Business Week, citing his "prescient analysis" of the role of technology in the free economy (Klesney 2001). Schumpeter has become a protagonist of the mainstream, not in academic economics ("standard textbook economics"), but in economic policy, management studies, industrial policy, and the entire area of innovation. In fact, the concept of entrepreneurship cannot be fully understood without his contributions.
The European Union's innovation program, and its main development plan, the Lisbon Strategy, are based on Schumpeter’s theories and ideas.
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