Rediscovering Schumpeter: The Power of Capitalism

Economist Joseph Schumpeter was perhaps the most powerful thinker ever on innovation, entrepreneurship, and capitalism. He was also one of the most unusual personalities of the 20th century, as Harvard Business School professor emeritus Thomas K. McCraw shows in a new biography. Read our interview and book excerpt. Key concepts include:
  • Schumpeter's ideas on capitalism, entrepreneurship, and innovation still have great resonance to students and businesspeople today.
by Sean Silverthorne

If capitalism was the most influential single economic and social force of the 20th century (and continuing today), there is no better guide to understanding its power and complexity than famed economist Joseph Schumpeter, says Harvard Business School's Thomas K. McCraw. “I think Schumpeter is the most penetrating analyst of capitalism who ever lived. He saw things other people didn't see.”

McCraw, a past winner of the Pulitzer Prize for History, has written a new biography, Prophet of Innovation: Joseph Schumpeter and Creative Destruction, which weaves together threads of social, business, and economic histories to illuminate Schumpeter's life and work. A central theme details how Schumpeter's insights help us understand how the forces of capitalism, innovation, and entrepreneurship continue to transform the world today.

Making the story even more compelling is Schumpeter's charismatic personality. Something of a dandy, Schumpeter (1883-1950) was a hit with women, adored by students, and both made and lost a fortune in a matter of years. He also once initiated a sword fight with a librarian—and won.

McCraw, the Isidor Straus Professor of Business History Emeritus, discusses his research and thoughts on Schumpeter's legacy in this e-mail interview.

Sean Silverthorne: What attracted you to research and write about Schumpeter? And why the title Prophet of Innovation?

Thomas McCraw: I first encountered Schumpeter many years ago, as an undergraduate, and I've enjoyed reading his works ever since. But the main reason I wrote this book is the tremendous resonance his ideas have had with my HBS students and with businesspeople.

I think Schumpeter is the most penetrating analyst of capitalism who ever lived. He saw things other people didn't see, partly because he lived in 7 different countries. He also served briefly as Austria's finance minister and worked for 3 years as an investment banker, where he made a fortune that he promptly lost in a stock market crash. So he wasn't a typical academic, even though he spent most of his career as a professor, including almost 20 years at Harvard.

As for my title, here's the quotation that inspired it: "Without innovations, no entrepreneurs; without entrepreneurial achievement, no capitalist returns and no capitalist propulsion." Schumpeter wrote this sentence during the Great Depression of the 1930s. Many, many smart people of that time believed that technology had reached its limits and capitalism had passed its peak. Schumpeter believed the exact opposite, and of course he was right.

Q: Schumpeter introduced the term “creative destruction” and championed the role of the entrepreneur in both start-ups and in established companies. What can business leaders take away from his development of these ideas?

A: The main takeaway is the absolute relentlessness of creative destruction and entrepreneurship. In a free economy, they never stop—never. Schumpeter wrote that all firms must try, all the time, "to keep on their feet, on ground that is slipping away from under them." So, no serious businessperson can ever completely relax. Someone, somewhere, is always trying to think of a way to do the job better, at every point along the value chain. Whatever has been built is going to be destroyed by a better product or a better method or a better organization or a better strategy.

Schumpeter believed the exact opposite, and of course he was right.

This is an extremely hard lesson to accept, particularly by successful people. But business is a Darwinian process, and Schumpeter often likened it to evolution. The creative destruction can occur within a large innovative company (Toyota, GE, Microsoft), but it's much more likely to happen with start-ups, particularly since they now have so much access to venture capital. Schumpeter, by the way, was one of the first economists to use that term. He wrote an article in 1943 in which he speaks of "venture capital."

Q: Capitalism, Socialism and Democracy is perhaps Schumpeter's best-known work. What makes it so rich and provocative even half a century later?

A: Chapter 7, "The Process of Creative Destruction," is only 6 pages long, but it perfectly captures the essence of capitalism. The 2 chapters preceding and the 2 following it flesh out the argument. So in the space of a little more than 40 pages, we have probably the richest material ever written on the broad subject of capitalism. The rest of the book is full of provocative ideas on politics, economics, and society, from ancient times to the present.

Schumpeter wrote some parts of the book in the form of satire. In his long analysis of socialism, for example, he seems to be arguing that it is a superior system. But this whole section is really an elaborate shell game. As Jonathan Swift, the greatest satirist writing in the English language put it, "Satire is a sort of glass wherein beholders do generally discover everybody's face but their own." Some readers actually came away from Schumpeter's book believing that he was a socialist. In fact, he was one of the most ardent defenders of capitalism of his time. But he was very subtle about it, trying above all to force his readers to think for themselves.

Q: You compare reading his books with listening to Beethoven's symphonies. What powers did Schumpeter command as a writer?

A: I made this comparison for 2 reasons. First, Beethoven's music is not always easy to understand—in contrast, for example, to Mozart's. (Mozart is the most widely recorded of all classical composers, and Beethoven second.) You have to be patient with Beethoven, and listen very carefully, sometimes over and over, to get the full message.

Another reason for the comparison is that Beethoven's music is grandiose and extremely romantic, and the same can be said of Schumpeter's writing—very unusual for an economist. But because capitalism is much more than just an economic system, Schumpeter made himself more than an economist. He was the most erudite economic scholar of his time, and perhaps of all times.

Q: Today, what would Schumpeter tell us about the evolution of capitalism in the 21st century?

A: Several economists, including Larry Summers and Brad DeLong, have said that the 21st century is going to be "the century of Schumpeter," and I agree. The reason is that innovation and entrepreneurship are flowering all over the world in unprecedented fashion—not only in the well-publicized cases of China and India, but everywhere except those areas that foolishly continue to reject capitalism.

The word "globalization" is accurate enough, but if anything it understates the case, in part because of the information revolution wrought by the Internet. This situation makes management harder and more challenging than it's ever been before. As a historian, I don't say that lightly.

Q: Schumpeter was a fascinating personality—a womanizer, incredible intellect, great teacher. And how many prominent economists have provoked a sword fight with a librarian? But at the same time, as your biography illustrates, Schumpeter could sink into self-doubt. What are your personal feelings toward the man? Did your impressions of him change while writing the book?

A: One of the joys of writing this book was dealing with Schumpeter's personal life. I knew it was going to be interesting, but not nearly so much as it turned out to be. His student Paul Samuelson, the first American to win the Nobel Prize in Economics, once said that Schumpeter was great as both a scholar and a personality, but that his comparative advantage may have been greater as a personality. I don't quite agree, but there's no denying his personal appeal, especially to women and to scholars and students of both sexes.

The duel you mention, by the way, was over students' access to books. Schumpeter had given out heavy assignments, the librarian had refused to allow the students to check out the assigned books, and when Schumpeter threw a tantrum (he was only 26, and had just started teaching), the librarian challenged him to a duel. Schumpeter won the duel by cutting a small slice out of the librarian's shoulder. The two men later became good friends, and the students got access to the books.

Like many geniuses, Schumpeter held himself to impossibly high standards, and he constantly brooded that he wasn't living up to them. There was extraordinary tension between his devotion to rationality ("I have given my life to reason," he once wrote in his diary), and the overwhelming power of his emotions. He was an intellectual prodigy, and, like many former boy wonders, was surprised to find that he could not work during his 40s and 50s at the furious pace he had set during his 20s. Even so, he did some of his very best work in middle age. Capitalism, Socialism and Democracy, for example, appeared when he was 59.

There's no denying his personal appeal, especially to women and to scholars and students of both sexes.

Then, too, he suffered some dreadful personal tragedies, such as the death of his 23-year-old wife in childbirth, and of his newborn son 4 hours later. This was the pivotal event of his life. In the months and years that followed, he drew on the great depth of his character—which went much deeper than he had realized—and redoubled his effort to work out the full complexity of capitalism as an economic, cultural, and social system.

As for my personal feelings about him, I think Schumpeter is one of those historical figures that anyone would love to have dinner with, as many people have said of Benjamin Franklin. He was just so witty, knowledgeable, and downright interesting that you couldn't come away without feeling enriched. Weaving together the fascinating story of his life with an interpretation of his great body of work made the writing of my book not only a challenge, but also a tremendous pleasure.