Economist Joseph Schumpeter: Father of Capitalist “Creative Destruction”

by | Feb 8, 2016

Schumpeter is famous as a leading 20th century formulator of the notion of the entrepreneur as dynamic innovator of change, and also as a master of the history of economic ideas.

Today is Austrian-born economist, Joseph A. Schumpeter’s, birthday. Born on February 8, 1883, he died on January 8, 1950. Schumpeter is famous as a leading 20th century formulator of the notion of the entrepreneur as dynamic innovator of change, and also as a master of the history of economic ideas.

Trained as an economist at the University of Vienna in the early years of the 20th century under the mentorship of such leading members of the Austrian School as Eugen von Böhm-Bawerk and Friedrich von Wieser, he went his own way being greatly impressed and influenced by the mathematical approach of Leon Walras’ general equilibrium formulation of the marginalist concept.

Already at the young age of 25, he demonstrated his wide interdisciplinary reading when he published in 1908, “The Nature and Essence of Economic Theory,” in which he showed his orientation toward Walras’ mathematical economics and an agreement with aspects of “positivist” methodology concerning the nature and subject-matter of economic theory. However, what one also finds in this early work is a clear statement and formulation of “methodological individualism” as the logical starting point for economic and social analysis.

But it was his 1911 volume, “The Theory of Economic Development” that established for the rest of his life an international reputation as an original and creative thinker. Using as a starting point the “circular flow” of an economy in general equilibrium, Schumpeter introduces the idea of “the entrepreneur” who breaks out of the routines of existing methods and forms of production with radical innovations in the types of goods produced, the methods with which they are produced, the organizational structures within which enterprises are arranged, and cost-efficiencies through which goods are brought to the market.

Schumpeter uses these elements to explain the possible workings of a bank credit cycle through which these innovative entrepreneurs are funded to bring about radical transformations in the interdependent structures of the market economy.

As a complement to this theory of credit expansion to fund and transform production that carries with it a form of the business cycle, Schumpeter in 1918 published a long essay on “Money and the Social Product” in which he attempts to explain the determination of the value of money. But included in this analysis is a clearly explained exposition of the inherent non-neutrality of changes in the quantity of money that in a temporal-sequential process brings about both temporary and permanent changes in the structure of relative prices, production activities, and the distribution of income, depending upon the “injection” points through which additions to the money supply are introduced into the economic system.

These themes remained continual elements in Schumpeter’s writings over the decades, and many of the essays on these and related themes may be found in a collection of his shorter pieces edited by Richard V. Clemence in 1951 under the title: “Essays on Entrepreneurs, Innovations, Business Cycles, and the Evolution of Capitalism.” The volume includes Schumpeter’s short but scathing review of John Maynard Keynes’ “The General Theory of Employment, Interest, and Money.”

Schumpeter’s constant interest in monetary and business cycle matters was also shown in what he had clearly hoped would be recognized as a “masterwork” of his, the two-volume “Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process,” which appeared in 1939. At one level this was supposed to be his alternative to Keynes’ “The General Theory,” which had been published in 1936. Dense, difficult to read, and nearly impossible to easily find the central threads to which the exposition was meant to lead the reader, Schumpeter’s massive book was poorly received, and without any noticeable impact within the economics profession.

Schumpeter is famous for coining the phrase “the perennial gale of creative destruction” to capture his conception of the constant and continuous workings of the dynamic and entrepreneurially driven capitalist system, in his 1942 work, “Capitalism, Socialism and Democracy.” Here he argues that the static and timeless equilibrium-focused notions of “perfect competition” and “monopoly” as presented in economics textbooks are hopeless and worthless for appreciating and understanding the true dynamic nature of capitalism and entrepreneurship.

In spite of his seemingly explicit rejection of the “Austrian” approach to economic theory, it is in his writings on entrepreneurship, the market process, and the “dynamics” of real world competition that one sees the continuing influence of his “Vienna” roots in his conception of the market economy and its workings.

His book, “Capitalism, Socialism, and Democracy,” is also famous for another element as well: Schumpeter’s deep fatalism and pessimism that capitalism was doomed and socialism (in some form) was inevitable. He was clearly impressed and influenced by Karl Marx as a sociologist analyzing the tendencies and directions of capitalist society. But Schumpeter was anything but a Marxist, though always fascinated by the Marxian worldview and its appeal in the intellectual and practical world in which he lived.

This interest is see in his well-known essays, “The Sociology of Imperialisms” (1919) and the “Social Classes in an Ethnically Homogeneous Environment” (1927), the first of which is meant to be a critical response to the Marxian and Leninist theories of imperialism as an end-stage of the capitalist process. Schumpeter sees late nineteenth and early twentieth centuries imperialism as an atavism, a throwback, to a pre-capitalist mode of conquest and exploitation. And his analysis of social classes is meant to challenge, again, the Marxian idea that “class” is defined by the individual’s relationship to ownership of the means of production.

In numerous places in his writings Schumpeter explains the classical liberal world before the First World War in words and phrases that clearly show his sadness of its passing and the arrival of variations on the social and economic collectivist themes. Shortly after the First World War, he was invited to serve on a committee of “experts” to advise on how to “socialize” industry in postwar Weimar Germany. When someone asked how he could serve on such a committee, given that he, Schumpeter, opposed socialism, Schumpeter replied that if a man is determined to commit suicide, then a physician should at least be present as a witness!

Schumpeter was a master of the history of economic ideas. In 1912, he published “Economic Doctrine and Method,” which though relatively brief in length (only 200 pages in the English translation), shows a breath and depth of reading and insight that might be considered unusual for a young man of 29 years of age.

Over the years he wrote a number of shorter and longer essays on famous economists and their ideas, including biographical and interpretive studies of Karl Marx, Carl Menger Alfred Marshall, Vilfredo Pareto, Friedrich von Wieser, and John Maynard Keynes. One of particular note is his lengthy and detailed appreciation of the life and work of his early Austrian mentor, Eugen von Böhm-Bawerk. They are included in the volume, “Ten Great Economists: From Marx to Keynes” (1951).

Many of his other important essays may be found in “The Economics and Sociology of Capitalism” edited by Richard Swedberg and published in 1991, including, ‘The Crisis of the Tax State’ (1918) and ‘An Economic Interpretation of Our Time’ (1941).

But his true masterwork in the field of economic ideas was his posthumously published, “History of Economic Analysis” (1954), which was partly unfinished at the time of his death in 1950. Running for 1,200 pages, the reader is awe-struck by the immense knowledge and insight Schumpeter possessed about the evolution and development of economic ideas from ancient times to the present, in extraordinary detail and richness over virtually every aspect of economic theory and practice. Even when the reader does not agree with all of his arguments or interpretations, one remains in the company of and learns from one of the great minds of 20th century economics.

Always presenting himself as an eclectic and a social scientist standing above and outside of the sectarian bickering of “schools of economic thought,” Schumpeter never fostered or generated a “Schumpeterian” school. As such, his writings have been admired, criticized and sometimes utilized by others, especially his conception of the entrepreneur and entrepreneurial innovation and change. But they have always, like himself, stood outside of the mainstream of economics, with most economists not knowing how to incorporate his ideas of “creative destruction” or entrepreneurial innovation within the mostly equilibrium models of neoclassical economics.

In my view, this is due to the fact that Schumpeter, like his “Austrian” intellectual cousins whom he chose to disassociate himself from, always saw the real essence of economics to be outside of and beyond the confines of mathematical equilibrium, a world of creative and innovative human actors introducing change and initiating market processes that just cannot easily (or at all) be made to fit within the constraints of the mathematical techniques that he insisted were the proper tools of a truly “scientific” economics. Not able to escape from the Walrasian equilibrium economics he so much admired, he could not construct an alternative schema for a market process analysis that his views of entrepreneurship and dynamic competition cried out for. And, thus, many of his “positive” contributions to economics remain outside of and unutilized by the mainstream of the economics profession.

Finally, when Lionel Robbins reviewed Schumpeter’s “History of Economic Analysis” in 1955, he ended with the following description of the last time he saw Joseph Schumpeter:

“The last time I met Schumpeter was on a river picnic in the middle 1930s. He had turned up unexpectedly from the United States on the day of our annual seminar outing at the [London] School [of Economics]; and he was immediately co-opted as an honorary member, so to speak, and pressed into joining the excursion.

“It was a lovely day in June; and as we glided down the Thames between Twickenham and Datchet, I can still see him, cheerfully ensconced in the prow of our ship, surrounded by the eager spirits of the day, Nicky Kaldor, Abba Lerner, Victor Edelberg, Ursula Hicks . . . [with] the four fingers and thumb of each hand pressed against those of the other, discoursing with urbanity and wit on theorems and personalities. So I conceive of this book, a splendid excursion down the river of time, with good talk and magnificent vistas.”

This captures, in my view, the experience of reading virtually all of Joseph Schumpeter’s writings – “a splendid excursion down the river of time, with good talk and magnificent vistas” – and as such he remains, in many ways, one of those timeless and uniquely thought-provoking contributors to economics.

Dr. Richard M. Ebeling is the recently appointed BB&T Distinguished Professor of Ethics and Free Enterprise Leadership at The Citadel. He was formerly professor of Economics at Northwood University, president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).

The views expressed above represent those of the author and do not necessarily represent the views of the editors and publishers of Capitalism Magazine. Capitalism Magazine sometimes publishes articles we disagree with because we think the article provides information, or a contrasting point of view, that may be of value to our readers.

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