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Thursday, May 17, 2007

Robert Solow on Joseph Schumpeter

Robert Solow reviews Prophet of Innovation: Joseph Schumpeter and Creative Destruction, by Thomas K. McCraw:

Heavy Thinker, by Robert M. Solow, TNR [open link]: I knew Joseph Schumpeter only in the last five years of his life, from 1945 until his death in 1950, at the age of sixty-six. To say that I knew him is actually a bit of an exaggeration..., I attended his courses on advanced economic theory and the history of economic thought. The theory lectures bordered on incoherent ... The history lectures were also disappointing. ...

Maybe it is just as well to slide over Schumpeter's failings at the end. He was past his peak; and the economics profession was moving in a direction--rigorous theory couched in mathematical terms--that he had always professed to admire but simply could not practice himself. ...

In 1940 Schumpeter seriously contemplated leaving Harvard to accept a ... more attractive offer from Yale. His senior colleagues at Harvard--some able, more of them drab--sent him a letter urging him to stay; it said the right things, but was perhaps a little perfunctory. A much more urgent, heartfelt, and mind-felt letter was signed by twenty-six junior faculty and advanced graduate students. The authors included the flower ... of the future of American economics. You have to admire the man who evoked those words from those people.

I wish I had known him then. It is to Schumpeter's eternal credit that, at a time when mediocrity often cottoned to mediocrity in Harvard economics, he stood always for intellectual quality and energy, regardless of ideology, ethnicity, or social position. McCraw makes this very clear, and understands its importance.

In recollecting Schumpeter, it is hard to tear oneself away from the exotic manner, the dubious politics, the carefully crafted image, the hidden self-doubts, the convoluted life story... McCraw covers all these in great and often fascinating detail. He makes full use of Schumpeter's diaries, which is where we learn of his self-doubt; it certainly was not evident in his public manner. ... Still, what really matters are Schumpeter's writings--the books and a couple of essays; and that is where I have something to add. ...

In my view--and that of most contemporary economists, I believe--Schumpeter's most original and most lastingly significant book was Theory of Economic Development, which appeared in 1911 (and was translated into English in 1934). It was at the University of Czernowitz, ... that he worked out his conception of the entrepreneur, the maker of "new combinations," as the driving force and characteristic figure of the fits-and-starts evolution of the capitalist economy. He was explicit that, while technological innovation was in the long run the most important function of the entrepreneur, organizational innovation in governance, finance, and management was comparable in significance.

Innovation is not the same thing as invention. Anyone can invent a new product or a new technique of production. The entrepreneur is the one who first sees its economic viability, bucks the odds, fights or worms his way into the market, and eventually wins or loses. Each win means profit for the entrepreneur and his backers, and it also means a jog upward for the whole economy. In the course of this process, which cannot possibly run smoothly, many businesses, individuals, and institutions, themselves founded on earlier successful innovations, will be undermined and swept away. Schumpeter called this birth-and-death process "creative destruction," and realized before anyone else that it was the main source of economic growth. There is no feasible alternative for capitalism; this is capitalism. ...

The picture generated by classical and neoclassical economics had none of this dynamism, turbulence, and intrinsic uncertainty. (Malthus was perhaps a partial exception.) Smooth trends and stationary states, equilibria of one kind or another, predominated. ...

Schumpeter derived from this analysis a lasting bias in favor of big business. "American opinion is so anti-big business," he wrote, "precisely because big business has made the country what it is...: who is not a part of big business feels he does not meet the standard and by compensation turns against it." Clearly a successful innovation confers, in his view, at least a temporary monopoly. Without the lure of those monopoly profits, there would be no incentive for anyone to bear the risks of entrepreneurship. Schumpeter believed that large firms were both the source and the result of successful innovation; and so tampering with them would be dangerous. ...

I think that this is Schumpeter's main legacy to economics: the role of technological and organizational innovation in driving and shaping the growth trajectory of capitalist economies. Whole subfields of economics now pursue the subject of the care, feeding, and consequences of innovation...

I agree with [McGraw] that the two-volume Business Cycles of 1939 was a massive failure... Schumpeter probably intended it as his entry in a competition with Keynes's General Theory, which appeared three years earlier, but it made no visible impression on the profession or the public. ...

McCraw does not really discuss the main piece of new intellectual machinery that Schumpeter hoped to impose on the jumble of business-cycle history to convert it into a comprehensible tale. That was a system of three oscillations or waves superimposed on one another: a forty-month Kitchin cycle, a roughly ten-year Juglar cycle, and a long Kondratieff cycle of about fifty years. (Kitchin and Juglar were economists of considerable obscurity, and Kondratieff only a little less.) I don't suppose that anyone under the age of eighty remembers any of this, though there remain a few devotees of the Kondratieff cycle. ...

This three-cycle scheme is a pointer to the main theoretical flaw in the book. Schumpeter wanted to place the entrepreneurial innovation process at the heart not only of episodic growth but also of the repetitive "business cycle" (or at least of the two longer species of cycles). McCraw seems to go along. But it does not work. After considerable experimentation, economics has given up on any such periodicities. .... Instead, "the business cycle" has become shorthand for the series of irregular, short-run, aggregative fluctuations of varying duration, magnitude, and--probably--causation...

Schumpeter had a rise-and-fall mechanism in mind. The monopoly profits collected by a successful entrepreneurial firm attract imitators and competitors, many of which are financed by fresh credit. This activity eventually erodes the initial profits; and then the time is ripe for another innovation, if one comes along. There is obvious truth to this story, but it is far from being a theory of economy-wide fluctuations.

Business Cycles was surely a great disappointment to its author. ... It must have used up a dreadful amount of even his enormous energy. And the world of economics just kept on arguing about Keynes.

In 1942, Schumpeter published Capitalism, Socialism, and Democracy, which was reprinted and translated many times. It was his most successful book by a wide margin.... McCraw thinks of it as a landmark of twentieth-century social science... I do not think it comes close to being that important; but I have to admit that I have a general distrust of ambitious, overarching attempts to capture a whole socioeconomic system in a few grand generalizations.

The book reiterates the standard Schumpeterian vision of capitalist turmoil and transformation, with the entrepreneurs as the indispensable heroes. This time he suggests a mechanism within capitalist society that (inevitably?) causes it to undermine itself. The children and grandchildren of successful entrepreneurs, precisely the people with the right DNA, are seduced by inherited wealth into intellectual pursuits, the arts, aristocratic habits, perhaps even into left-wing or at least anti-capitalist ideologies. It is not the proletariat that blows up the capitalist edifice, which is in fact good for the proletariat. It is the second generation of successful entrepreneurs that lets the ground floor decay. ...

Which brings us to the "democracy" in Schumpeter's title. He was not a democrat by instinct or by reflection. He had little confidence in the ability of the average citizen to vote intelligently... His book asks if democratic socialism is possible. The conclusion is that perhaps it is possible in principle, but almost surely not in practice. Democratic capitalism is what we have, but democratic resentment and democratic ignorance tend to work against capitalist success, either by accepting socialism or by fostering over-regulation.

For these reasons, Schumpeter could not conceive that a permanent mixed economy was a viable proposition. He called it "capitalism in an oxygen tent." For him, capitalism is the civilization of a few family fortunes and broad inequality. Democracy, he thought, must turn out to be "laboristic," and therefore inimical to capitalist success. This conclusion was a major error, as McCraw says. It has been soundly contradicted empirically by the sixty years and counting since World War II. ...

I will not discuss History of Economic Analysis, edited and published after his death by his wife Elizabeth Boody Schumpeter. It is very long and very recondite. ...

[I]n his later years, he thought about writing a treatise that would summarize "Schumpeterian economics." Most especially he contemplated a "preliminary volume" that would summarize the treatise to come, and would tell his story in a style that could reach a broader professional and non-professional audience. This was clearly intended as his answer to Keynes. The internalized rivalry with Keynes, his exact contemporary, for the title of World's Leading Economist seems to have nagged frequently at Schumpeter.

But he seemed not to understand what Keynesian economics was about, or why it won over the younger generation. For example, he described Keynes as the apostle of consumer spending (in contrast to his own emphasis on innovational investment). But in fact consumer spending is passive in Keynes's General Theory. The driving force of the aggregate economy is actually investment spending; and Keynes put great causal weight on "animal spirits" and "the state of long-run expectations," both of which are much more akin to entrepreneurial drive.

Similarly, Schumpeter charged Keynes with being a "stagnationist" (in contrast to his own belief that there was no natural limit to entrepreneurial energy and innovation). This is a more complicated matter. The Keynesian framework could accommodate stagnationist ideas about the drying-up of profitable investment opportunities; and in other hands it did. Keynes certainly did not admire "money-grubbing," and he would have classified a hot-to-trot Schumpeterian entrepreneur as a money-grubber. That is not stagnationism. It is probably more accurate to say that Keynes erred in a different way, by thinking that consumers might become satiated as their incomes rose...

It is possible to see Keynesian and Schumpeterian ideas as complementary. Keynes is about short-run economic fluctuations brought about by erratic variations in the willingness of investors and governments to spend; Schumpeter is about the long-run trajectory driven by the erratic march of technological progress. This complementarity only became clear later, after both men had died, when economic growth became an explicit objective of public policy and topic of systematic analysis. Schumpeter was left frustrated by the younger generation's affinity for his rival. In any case, the "preliminary volume" never materialized. ...

Today, some sixty years after their deaths, Schumpeter's star probably outshines Keynes's. The business cycle has receded in importance, partly because the large industrial economies have sprouted a more stable structure, and partly because the lessons that Keynes taught have been learned by central banks and finance ministries. Instead, long-term economic growth has moved to the top of the political and intellectual agenda, and that was Schumpeter's topic. As Robert Lucas memorably put it, once you have begun to think about economic growth, it is hard to think about anything else. It is a pity that troubled old Schumpeter did not live to see the triumph of his obsession. ...

    Posted by on Thursday, May 17, 2007 at 09:36 AM in Economics, History of Thought | Permalink  TrackBack (0)  Comments (12)

          

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