– July 14, 2020

The Fraser Institute in Vancouver, British Columbia, has put together a series of very useful introductions to the key ideas of some great thinkers in their Essential Thinkers series. They started with The Essential Hayek (by Donald J. Boudreaux) and then moved on to The Essential Adam Smith (James Otteson), The Essential John Locke (Eric Mack), and The Essential Milton Friedman (Steven Landsburg). Their most recent contribution to the series comes from Russell A. Sobel and Jason Clemens. They introduce us to The Essential Joseph Schumpeter in yet another volume that can be downloaded for $0 and, at just a few dozen pages, read very quickly.

Schumpeter (1883-1950) was a brilliant economist and, apparently, quite a character. He is said to have boasted that his goal in life was to become the world’s greatest economist, the world’s greatest lover, and the world’s greatest horseman. When someone asked him how things were going, he said that things weren’t going so well with the horses. Between that kind of sly wit, his brilliant mind, and his disciplined work ethic, you can see how Schumpeter became one of the twentieth century’s most interesting economists. Fortunately, his ideas (and not just his quick wit) warranted it.

Schumpeter was very prolific, but four key works stand out: The Theory of Economic Development (German edition 1911, English edition 1934), Business Cycles (1939), Capitalism, Socialism, and Democracy (1942), and the posthumously published, incomplete but still very important History of Economic Analysis (1954). Schumpeter was the complete scholar, asking and answering very big questions while appreciating and understanding their intellectual history and context.

This has some important implications for cottage industries about what this or that thinker really meant or the nature of social processes very generally. Understanding all this stuff at a very deep level requires more than just knowledge of what has been published in the American Economic Review in the last year. Schumpeter argued that to really understand Karl Marx one must read all three volumes of Capital, the entirety of Theories of Surplus Value, and have a strong working knowledge of British political economy, French socialism, and the German philosophical tradition. That’s a tall order, but the Bible exhorts us to “get understanding.” I think it’s worth it (I admit my view is idiosyncratic).

One of Schumpeter’s most important contributions is a rethinking of how we understand competition. As Sobel and Clemens point out, Schumpeter’s main criterion for whether or not a market was competitive concerned its contestability. The relevant question was not “how many firms are in this industry” but “what are the barriers to entry that are preventing firms from coming up with substitutes?” The workhorse models of perfect competition that economists use to understand so many things are of great value as models; however, if Schumpeter is right, then they are limited in their ability to tell us how the world should be.

Sobel and Clemens explain Schumpeter’s argument in the context of an interesting example: Hawaiian pizza, which, it turns out, is actually Canadian–”The creation of Hawaiian pizza is often credited to Sam Panopoulos, who first cooked one at the Satellite Restaurant in Ontario, Canada in 1962”–and is now the most popular pizza in Australia (p. 9). My wife and I have an inside joke referring to “feta cheese and spinach pizza” because early in our relationship I apparently told her repeatedly about the amazingness of the feta cheese and spinach pizza at Tut’s on the strip in Tuscaloosa, Alabama. The point Sobel and Clemens make is that there are many thousands of possible combinations of pizza toppings. Economic progress happens when we stand back and let innovators like Sam Panopoulos try something new and see if it works, where “works” is judged by the difference between consumers’ willingness to pay for dough, sauce, cheese, ham, and pineapple combined into a pizza and their willingness to pay for dough, sauce, cheese, ham, and pineapple used for literally anything else. Karl Marx and Friedrich Engels were right

“The bourgeoisie cannot exist without constantly revolutionising the instruments of production, and thereby the relations of production, and with them the whole relations of society. Conservation of the old modes of production in unaltered form, was, on the contrary, the first condition of existence for all earlier industrial classes. Constant revolutionising of production, uninterrupted disturbance of all social conditions, everlasting uncertainty and agitation distinguish the bourgeois epoch from all earlier ones. All fixed, fast-frozen relations, with their train of ancient and venerable prejudices and opinions, are swept away, all new-formed ones become antiquated before they can ossify. All that is solid melts into air, all that is holy is profaned, and man is at last compelled to face with sober senses his real conditions of life, and his relations with his kind.”

One would definitely get the impression from online debates about the propriety of pineapple as a pizza topping that Panopoulos has in fact “profaned” something that is “holy.” Fortunately, he didn’t have to ask anyone’s permission–and as measured by market tests, he has improved his fellows’ “real conditions of life.”

Innovation, according to Schumpeter–his famous “perennial gales of creative destruction”–drive both economic development and business cycles. His arguments have been formalized and extended by Philippe Aghion and Peter Howitt, and economic historians like Joel Mokyr and Deirdre McCloskey have highlighted the importance of innovation and, importantly, a culture that embraces innovation. Economic progress doesn’t come about from there being an infinite number of price-taking buyers and sellers of products identical to the original iPhone. It comes from the fact that Apple introduces a newer, better iPhone every year. Competition, for Schumpeter, is not entry and exit or expansion or contraction of output in perfectly competitive markets. It’s the introduction of new products and new ways of doing things.

Barriers to entry are of utmost importance. Sobel and Clemens point out that about 700,000 American businesses succeed every year and another 600,000 fail. There is constant churn. Both, I suspect, are too low, and I think Schumpeter would agree. A lot of businesses don’t get a chance to succeed or fail because they are crushed by taxation and regulation very early on–or because the aspiring innovator looks at the regulatory burden she will be expected to bear and decides it simply isn’t worth it. 

Schumpeter makes an argument that will strike a lot of lay readers as counterintuitive. We should welcome (or at least tolerate) business failures because they free up resources that are being wasted and that, importantly, will continue to be wasted if the businesses don’t fail. I’m reminded of something I recall H. Ross Perot saying during his ill-fated Presidential campaigns in 1992 and 1996, that we wanted big American companies to be growing. That’s only the case if those companies are creating value, on net, as measured by market tests of profits and losses. Losses tell firms that they are wasting resources and provide a stern warning: turn from your wicked and wasteful ways, and start producing goods and services that people are willing to “vote” for with the fruit of their labor and the sweat of their brow. Or else.

This, of course, depends on the institutional context, and alas, there are a lot of businesses that “succeed” that shouldn’t. Their “success” comes from bailouts (airlines after 9/11, banks during the Great Recession, airlines and hotels during COVID-19), protectionism (sugar cane farmers in Louisiana and Florida, sugar beet farmers in North Dakota), subsidies (in their introductory textbook, Tyler Cowen and Alex Tabarrok point to farmers in California who spray subsidized water on subsidized crops growing on subsidized land), or some combination of these.

Schumpeter’s story begins in earnest in 1901 at the University of Vienna, which was at the time one of the world’s great universities–”comparable to Oxford and Cambridge,” in the words of Sobel and Clemens. He was a classmate of Ludwig von Mises and a student of Eugen von Boehm-Bawerk–a couple of decades later, he would take Boehm-Bawerk’s old post as Austrian Minister of Finance. If I recall correctly, Boehm-Bawerk taught a seminar on Marx that included as students Schumpeter, Mises, Rudolf Hilferding, and Otto Bauer. To digress, to have been a (German-speaking) fly on the wall for that seminar would have been amazing. He started his graduate training in 1908 and, having already made some important scholarly contributions, he was certified to teach. Unable to remain at Vienna, he started at the University of Czernowitz (in modern Ukraine), where he wrote the first version of The Theory of Economic Development. He moved to the University of Graz in 1911. After a split from his first wife, he became Austrian Minister of Finance in 1919. Schumpeter left academia in 1921 to pursue a financial career. He became very rich but lost everything when the market crashed. He returned in 1925, taking an appointment at the University of Bonn, and spent a considerable amount of time for the rest of his life repaying debts he had incurred as a result of his ill-fated financial adventures.

In 1926, he was struck by a triple tragedy. First, his mother died. Not long after, his new wife Anna Josefina Reisinger and their newborn daughter both died during childbirth. The losses devastated him. As Thomas McCraw put it in his 2007 biography of Schumpeter titled Prophet of Innovation, pp. 151-152, 

“In order to function at all, he looked for some way to keep drawing on the support of Johanna [his deceased mother] and Annie [his deceased wife]. In his diary, he began to refer to them as his Hasen, a German pet name for dear ones (its literal meaning is ‘rabbits’). Week after week, he would write ‘O Mother and Mistress, help me,’ and ask for the strength to do his research and writing….His salvation came from work and still more work, all sustained by these ritualistic appeals to his wife and mother.”

In 1932, Schumpeter crossed the Atlantic to join the faculty at Harvard, where he excelled both in his writing and in his teaching. His external gregariousness masked his inner darkness. As McCraw writes (p. 212),

“Light-hearted at chipper in public, Schumpeter lived an altogether different life in private–a continuing, desperate internal struggle with melancholy. His weekly diary entries still began with thanks and appeals to the Hasen, then lapsed into something like self-flagellation over the slow progress of his research.”

Schumpeter’s dark nights of the soul, I think, might be a welcome balm for graduate students and other scholars frustrated by the (lack of) progress of their own work. If even Schumpeter struggled to get his work done, then maybe the rest of us should lighten up on ourselves a little.

Sobel and Clemens take us through brief and easy analyses of Schumpeter’s theory of economic development (driven by innovation) and his theory of business cycles (where major innovations draw capital into the newly innovative sector with the cycle happening as the economy adjusts to the new technological and commercial possibilities. In Schumpeter’s most famous book, Capitalism, Socialism, and Democracy, he makes a lot of arguments about the democratic process that would later be carried forward by the public choice school of economics. Indeed, as Sobel and Clemens note, Anthony Downs explicitly acknowledges his intellectual debt to Schumpeter in his 1957 The Economic Theory of Democracy. There is not, Schumpeter argued, a single “common good,” and likely drawing on his experience as Austrian Minister of Finance he explained, as James M. Buchanan and Gordon Tullock would some two decades later, that we cannot assume political actors have the “public interest” in mind–or if they do, that their conception of the public interest is accurate. To Schumpeter, and as the philosopher Jason Brennan would argue in his 2016 book Against Democracy, “politics makes us mean and dumb.”

Schumpeter also argued that capitalism sowed the seeds of its own demise, but with a twist. Where Karl Marx saw capitalism falling because of an uprising by the proletariat, Schumpeter saw it falling because the intellectuals and the bourgeoisie would turn against it. They both agreed that socialism would replace capitalism. For Marx, this was inevitable and a good thing. For Schumpeter, it was inevitable and a bad thing. In a sense, Schumpeter was right: communism and socialism have never happened because of revolutions from below. They have always been revolutions led by intellectuals.

Joseph Alois Schumpeter made enduring and important contributions that have stood and will continue to stand the test of time. The specific institutional and historical context in which he wrote–the Keynesian Revolution that started in earnest shortly before the publication of his Business Cycles, and the enthusiasm for central planning within the political arena and the economics profession that provides a backdrop against which we can think about various editions of Capitalism, Socialism, and Democracy–makes him an important and illuminating figure in intellectual history per se. The Essential Schumpeter is a useful introduction to the man and his ideas, and both the text and the accompanying videos will serve students, instructors, and interested lay people very well.

Art Carden

Art Carden

Art Carden is a Senior Fellow at the American Institute for Economic Research. He is also an Associate Professor of Economics at Samford University in Birmingham, Alabama and a Research Fellow at the Independent Institute.

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