L’Enfant Terrible

Welcome to the Innovation & Entrpreneurship Reading Group’s Live Blog of Thomas McCraw’s Prophet of Innovation: Joseph Schumpeter and Creative Destruction.  The theme of the book is Schumpeter’s emphasis on capitalism as a process of creative destruction.  That is, entrepreneurship and innovation creates value and is the engine of the capitalist economy, but those that win at the game (successful entrepreneurs) leave a “gale of creative destruction” in their paths.  Hence, he sees capitalism as a positive-sum game, but not necessarily as making everyone better off.   Just ask any horse and buggy dealer.

The first chunk of the book, L’Enfant Terrible, covers the first 42 years of Schumpter’s life.  During that time, he had him traveling from Austria to England to Cairo to the United States, serving as a lawyer, a minister of finance, a businessman, and a scholar.   In the scholarship realm, depending on whom you believe, he wrote what was perhaps his defining work — The Theory of Economic Development.*

David Hounshell provides some context for this early work and Schumpeter’s entrepreneur, mark 1.

The entrepreneur is the innovator in Schumpeter’s conception. His original word for the entrepreneur was der Unternehmer, literally undertaker—not in the sense of mortician but from the French verb, entreprendre, to undertake. Schumpeter identifies the entrepreneur as the person who makes new combinations and carries them out. Entrepreneurs are change agents; they create the basis for economic growth.

So what does an entrepreneur do?  Hounshell sums it up:

In Theory of Economic Development , Schumpeter says that his concept of innovation covers five cases:

  1. The introduction of a new good—that is, one with which consumers are not yet familiar—or of a new quality of a good.
  2. The introduction of a new method of production, that is one not yet tested by experience in the branch of manufacture concerned, which need by no means be founded upon a discovery scientifically new and can also exist in a new way of handling a commodity commercially.
  3. The opening of a new market, that is, a market into which the particular branch of manufacture of the country in question has not previously entered, whether or not this market has existed before.
  4. The conquest of a new source of supply of raw materials or half-manufactured goods, again irrespective of whether this source already exists or whether it has first to be created.
  5. The carrying out of the new organization of any industry, like the creation of a monopoly position (for example through trustification) or the breaking up of a monopoly position.

On that final point (#5), the word trustification basically means a monopoly position, where the allure of monopoly profits leads entrepreneurs to seek out profits. Of course, a firm holding a monopoly position making big, tasty profits is a natural market for a would-be entrepreneur to contest.   This notion of a trustified position will become more central as we think about what types of industries are more innovative — those characterized by competition or those by monopoly.   The term entrepreneurial capitalism shows up quite a few times in the first part of McCraw’s book, and it has a specific meaning vis-à-vis managerial or trustified capitalism that emerges at the turn of the 20th century.   See, for example, Robert Litan’s remarks concerning the contemporary situation:

Our third form of capitalism is big-firm or managerial capitalism… Managerial capitalism has its advantages, which is one reason why Europe and Japan were able to recover rapidly after World War II. Large enterprises can exploit economies of scale and have the capital to routinize research and development, and thus innovation. But the innovation that emerges from large companies generally is more incremental than radical, and this defines the limitations of managerial capitalism…. If an economy is solely managerial, its growth inevitably will slow.

And so we come to entrepreneurial capitalism where fast-growing companies drive the economy. That’s us, or at least the way we were coming into the recession. But we were not always an entrepreneurial economy.

So we have the basis for Schumpeter’s view of capitalism as a dynamic process, driven by “undertakers” or what we might call “can do” types.   Non-economists reading this might be thinking, “Uh huh, so what?”   The so what here is that the idea of capitalism as a dynamic process was quite different conceptually to the equilibrium models that dominated (and still dominate) the economics landscape.   Thomas Leonard at Princeton provides some context:

The entrepreneur, however, was mostly missing from Anglophone economics, which had long followed David Ricardo by identifying productive function with membership in one of the  three great English socioeconomic classes at the turn of the 19th century: labor from the working  class, land from the aristocracy, and capital from the merchant class. The Ricardian triad left  little room for the entrepreneurial function; 19th century Anglophone economics tended to identify the entrepreneur with the capitalist, or with the manager. Robert Solow’s mid-20thcentury  growth theory recognized that Ricardian factors – more workers, more capital, or more  capital per worker — could not wholly explain economic growth. Innovation mattered, too. Yet, stuck with Ricardo’s framework, Solow did not explain innovation, he consigned it to the  statistical dustbin of a shift parameter.

We’ll revisit Solow as we get deeper into the book.   Suffice it to say, Solow was a giant in the profession, especially with regard to economic growth, so his thoughts on Schumpeter’s importance and influence are certainly relevant.

This brings me to my last point, which is the obvious overlap of Schumpeter’s life with that of John Maynard Keynes.   This certainly comes out in the tail end of the story, as Keynes and Schumpeter are both thinking and writing about the nature of depressions and the future of capitalism.  But what struck me was the reference to Schumpeter’s “The Crisis of the Tax State,” where he contemplates the economic restrictions imposed by the allies putting shackles on economic growth, hence making a future conflict inevitable.  I was unaware of this, but was familiar with Keynes’ Economic Consequences of the Peace, which drew the same conclusions.   I guess von Hayek is not the only economist in Keynes’  shadow.

Overall, as I completed L’Enfant Terrible,  I was struck by the impact that World War I must have had on everyone’s thoughts on economic and social systems.  As McCraw puts it, “[Europeans] had grown up believing that science, capitalism, and the spread of “European civilization” would bring continuous progress. Yet from 1914 to 1918 they witnessed, year after year, an endless pageant of senseless slaughter — the antithesis of progress.”

Hard to imagine.  Comments are open.   See you for The Adult.

*The sentence spawned a debate in the economics and government departments over whether that should be who or whom [That’s settled now. We think. (Ed.)].