Book Review: Bert Foer on Tom McCraw's Schumpeter

Jun 25 2007

By Thomas K. McCraw

The Belknap Press of Harvard University Press

Cambridge, Mass., and London, England 2007

719 pp (506 pp of text, the rest are notes)


 Reviewed by Albert A. Foer

Back in the mid-1970’s, when I was Assistant Director for Special Projects in the FTC’s Bureau of Competition, I received a fellowship grant from the National Endowment for the Humanities to study U.S. economic history at the University of California for a month. I returned to the FTC charged up with the sense that history has a lot to teach us about competition policy and, ignited by that spark, my office searched for a business historian who would put together a series of lectures and discussions for the FTC staff. To our great benefit, the historian we found was Thomas K. McCraw, then, as now, a professor at the Harvard Business School.  Tom lined up the great scholars in the field of business history, starting with his mentor, Alfred D. Chandler, Jr., and we had a tremendously invigorating program over the next several months. We edited the transcripts and released a report which is probably no longer available, although I cherish my copy. As far as I can tell, none of this had any impact on competition policy in the ensuing years.


            Tom McCraw went on to edit a fascinating collection of essays called Regulation in Perspective and in 1984 wrote Prophets of Regulation, which won the Pulitzer Prize for history. He also edited a book called Creating Modern Capitalism, which has been required reading for all the students at the Harvard Graduate School of Business Administration. In the preface to Prophets of Regulation, McCraw says, “My approach fluctuates between the lives of men, economic theory, and historical incident.” In that book, he provided biographical sketches of Charles Francis Adams, Louis D. Brandeis, James M. Landis, and Alfred E. Kahn. His latest book, Prophet of Innovation, features another biography but the same approach, to throw further light on the intellectual history of competition and regulation. It is worthy of a second Pulitzer.


            Joseph Schumpeter, who died in 1950 at the age of 66, is of course best known for his emphasis on the role of the entrepreneur and innovation in capitalism. His most widely read book was Capitalism, Socialism, and Democracy. McCraw believes his most important book, however, was the History of Economic Analysis that was published posthumously through the labors of Schumpeter’s wife, the economist Elizabeth Boody, who is “the noblest person in the story.”


            And the story is a fascinating one. Schumpeter was a European by birth and temperament, who arrived at Harvard to escape the Second World War. A scholar of great learning in many fields, his view of economics was always tempered by history, sociology, and other disciplines. During the European phase of his life, he started as an “academic wonder boy,” served unsuccessfully as Minister of Finance in Austria after the First World War, became a banker who made a fortune and lost it all in a stock market crash, and migrated to Harvard, penniless but already world-famous.


            Cheerful and mesmerizing in public, his inner life was a mess. A womanizer early in life but overly devoted to his extraordinary mother, his first marriage was never very strong and petered out during a war-created separation. His second marriage was quite different. “After decades of casual affairs and nonchalant dandyism, he became a devoted husband and a deliriously happy man.” But in the pivotal year of 1926, Annie, the wife who was twenty years younger than Schumpeter, died in childbirth along with the newborn son. His mother also died that year, and Schumpeter was never the same. “He grew much more serious, tapping into resources of character he had no idea he possessed.” Schumpeter’s diaries, which along with a trove of letters enrich the biography, show him regularly reporting to his dead wife and mother, whom he called his “Hasen,” almost a godhead. I will pass over Schumpeter’s self-doubts, his oddities, his anti-Semitic scribblings. Late in life he married Elizabeth Boody, an outstanding economist in her own right, who gave up much of her own professional potential in order to help Schumpeter carry out his self-imposed task of describing and explaining capitalism.


            Despite awesome productivity as a scholar, McCraw’s Schumpeter was also a wonderful and deeply caring teacher at Harvard. However, in a book review by Robert M. Solow in the May 21, 2007, issue of The New Republic (a magazine which for personal and other reasons I am always pleased to recommend), former Harvard student and Nobel economist Solow described a different Professor Schumpeter: a professor who, at least in his last five years of life, taught a course that “felt like a stage display of multilingual erudition,” and whose theory lectures “bordered on the incoherent.”   Solow concludes his review, “The man was all problems, and one very important idea.”


            I am neither economist nor historian and can’t comment on the disagreement about Schumpeter’s pedagogy, but the reduction of Schumpeter’s contribution to “one very important idea” seems a bit unfair. For example, Schumpeter seems to have had some important ideas about the role of credit creation in capitalism and he was an early exponent of the role of business strategy.  But the very important idea Solow is no doubt focused on, the key role played by innovation, was certainly boosted by Schumpeter’s showmanship and his way with words. “Perennial gale of creative destruction” is as colorful a phrase as one will find in the dismal science. Indeed, Schumpeter fastened onto one of the most dismal aspects of capitalism – its destruction of the status quo in order to open the way for the new—and turned it into not merely a positive cause of celebration but the very engine of progress and the key to understanding capitalism. Schumpeter saw the negative effects of destruction, but found that they were far outweighed by the benefits of innovation for the society as a whole.


            Capitalist economies, Schumpeter taught, are not accurately described by theories of perfect competition, which do not take business strategy into account. Rather, capitalism is dynamic, in continuous disequilibrium, led by entrepreneurs obsessed with what they are doing. Capitalism is a framework that makes innovation feasible. Innovation upsets the status quo, destroying established institutions that stand in the way so that the new may come into existence. “This process of Creative Destruction,” he so famously wrote, “is the essential fact about capitalism. It is what capitalism consists in and what every capitalist concern has got to live in.”


            What is it that drives entrepreneurs to innovate? Schumpeter credits more to human psychology and sociology than to other factors: the drive to make a mark and outshine others, rather than the lure of money or even the threat of competition, appears to play the foremost role for his entrepreneur, who is the agent of innovation. Schumpeter does not, therefore, worry about monopoly or oligopoly as possible impediments to innovation. He dismisses the kinds of efficiencies promoted by classical economics and its emphasis on the analysis of price. “In capitalist reality as distinguished from its textbook picture, it is not [that kind of] competition that counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization.” This kind of dynamic competition, which is potent even when it is merely an ever-present threat, “strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.”


            Not worrying about monopoly profits, which are no more than a minor concern and will only flow temporarily, Schumpeter believes that big business should be celebrated rather than constrained by antitrust. Apparently, this strain of thought carries great weight in today’s Justice Department and influences Justice Scalia and his majority on the Supreme Court.


            On this, there is room for a strong difference of opinion, starting with the question of what type of industrial structure is most conducive to innovation. Today’s consensus goes something like the following. In pure competition, where there are only price takers and no price makers, innovation is likely to be very limited because no present competitor is able to obtain a sustainable advantage and because profit margins are too narrow to sustain research and development. In pure monopoly, on the other hand, where there is enough profit to underwrite R & D, innovation is likely to be channeled to marginal improvements that do not fundamentally challenge the monopoly. Moreover, with very limited competition, the monopolist tends toward lethargy rather than risk-taking. Innovation is probably maximized when there are multiple-- but not necessarily a large number of-- competitors and they are following a variety of business strategies.  The role of actual competitors and potential competitors in stimulating innovation would seem to be greater than Schumpeter believed. Moreover, in the absence of antitrust, there are substantial opportunities for a monopolist to expand the monopoly’s reach and its life through the use of various exclusionary strategies.


            Schumpeter’s view of capitalism probably was too firmly attached to the models of pure competition and monopoly, without sufficient attention to the oligopolies in between. Moreover, with a Marxian education, he seems too committed to the politics of socialism and the economics of large scale production. Innovation on the small scale in garages was not within his foresight.


            In the triumph of big business which he advocated, Schumpeter saw the seeds of capitalism’s own destruction. A critical paragraph in McCraw’s biography is this:


The case for capitalism, says Schumpeter, “must rest on long-run considerations.” In the short-run, it is impossible for people generally, and even intellectuals, to ignore what seem to be unreasonable “profits and inefficiencies.” They therefore have difficulty in seeing long-range trends in which capitalism is benefiting society as a whole. Uniquely among economic systems, therefore, capitalism “creates, educates and subsidizes a vested interest in social unrest.” With its bountiful production, it underwrites the education of a class of hostile intellectuals who have no “direct responsibility for practical affairs” and little experience in managing anything.”


            McCraw, paraphrasing Schumpeter, concludes that “Economic efficiency is only one of many human goals, and not necessarily the most important to every individual. Thus the future of capitalism cannot be assured on the basis of its superior economic performance alone.”


            If capitalism creates its own enemies by destroying as it innovates and thereby-- as one of its inherent functions-- creates social unrest, one might logically conclude that government intervention should be an essential part of a healthy capitalist polity. Such intervention would not be for the purpose of protecting the losers from losing but to reduce the level of anxiety in the society resulting from the ever-present risks of change. It would accomplish this by guaranteeing various kinds of services and transfer payments to the losers, at least on a transitional basis. Schumpeter did not like government intervention in the economy as a general matter, but neither was he a believer in laissez faire. McCraw describes how Schumpeter struggled in his later writings toward an understanding, not noticeable in Capitalism, Socialism and Democracy, that there can be a stable middle way between laissez faire capitalism and socialism, namely a mixed economy.


            Subsequent experience has demonstrated that mixed economies do work. It is ironic that Schumpeter considered himself a conservative but was the advocate of an economic system based on constant change. It is even more ironic that as Schumpeter’s star has climbed in recent years, as the importance of economic growth as a national goal has itself grown on the public awareness, self-identified conservatives downplay antitrust, worry publicly about the constraints we place on monopoly, support trends toward economic concentration, and fawn over intellectual property as if it were a natural right that ought never be constrained because of its power to generate innovation—while at the same time undermining the mixed economy’s safety net that helps make the “creative destruction” of capitalism an acceptable system to the masses, including the defeated entrepreneurs and managers and employees who are the foreseeable casualties of the system.


            In a recent New York Times column, Tom Friedman reported on what he called Israel’s new oil wells, which turn out to be the imagination and risk-taking of young scientists and engineers at Ben-Gurion University who are working on a variety of potentially important innovations, for which venture capital apparently abounds. Schumpeter would have approved of the metaphor and would surely have approved of an economy in which innovation is given a high value and capital is available for investment in the new. While we remember him as a prophet of innovation and growth, however, the antitrust community should also remember many of the other ideas for which he took a stand: that national wealth can be created by proper employment of the human mind and not necessarily by war and plunder, that neoclassical models are inadequate, that empirical data is crucial, that strategies play a huge role in the marketplace, that psychology at the individual and firm level can be determinative, that creative change comes at the expense of destruction, and perhaps most important of all, that history counts. Tom McCraw gets all of this into his magnificent account of a fascinating economist whose ideas, though not all equally worthy, still wield influence.