Ed. Note: Occasional posts at MasterResource include big-picture entries on key social science thinkers that are relevant to understand dynamic market capitalism versus its opposite, political capitalism. This entry examines a leading twentieth-century thinker whose work continues to frame many debates in applied economics and political economy.

Brilliant, blithe, eclectic, and obsessive, the immaculately attired, aristocratic scholar [Joseph Schumpeter] captured the essence of entrepreneurial capitalism and introduced the terms “creative destruction” and “business strategy.” – Robert Bradley, Capitalism at Work: Business, Government, and Energy, p. 100.

“I set out to become the greatest lover in Vienna, the greatest horseman in Austria, and the greatest economist in the world. Alas, for the illusions of youth: as a horseman, I was never really first-rate.”

– Joseph Schumpeter, as recalled by student M. A. Adelman (Quoted in Ibid.)

Joseph Schumpeter (1883–1950) was the conscience of his profession, questioning the relevancy of an equilibrium-only approach for understanding business competition and economic growth. (Remember how static just about everything was that you learned in Micro 1.0 and 2.0?) Schumpeter was a methodological realist interested in the actual workings of capitalism, what he called capitalist reality.[1]

He also had a contrarian streak. He claimed allegiance to no school of thought and even feared becoming the orthodoxy himself. “When I see those who espouse my cause,” he averred, “I begin to wonder about the validity of my position.”

Entrepreneur as Revolutionary

Schumpeter’s theory of capitalist development centered upon the entrepreneur, a “swashbuckling … quasi-heroic” figure who disrupted routines and forged a new menu for consumers. Innovation was less about economizing within a known framework than about creating wholly new vistas.

The Schumpeterian entrepreneur did not say, “If it ain’t broke, don’t fix it.” He said, in effect, “Break it and make it better!” Incremental improvement was about routines and managers; by contrast, “the function of entrepreneurs,” Schumpeter stated, “is to reform or revolutionize the pattern of production by exploiting an invention or, more generally, an untried technological possibility for producing a new commodity or producing an old one in a new way, by opening up a new source of supply of materials or a new outlet for products, by reorganizing an industry and so on.”

Equilibrium Not

Such thinking led to a profound conclusion from the Austrian-born-and-trained economist: “The problem that is usually being visualized is how capitalism administers existing structures, whereas the relevant problem is how it creates and destroys them.”

In the energy field, dense fossil fuels ‘creatively destructed’ renewables in the 19th century and continue to do so today.

No equilibrium box could hold the Schumpeterian entrepreneur. Automatons populate equilibrium; human innovators preclude it. Many economists abandoned the study of entrepreneurship because it was not amenable to mathematical and diagrammatic portrayal. They were right, but the wrong thing was discarded. The open-ended world of disequilibrium was the reality that had to be comprehended, even if mathematical economics had to be demoted.

Much empirical study was required to formulate the relevant concepts and identify patterns. Theoretical economists had to team with business historians to understand in-the-flesh entrepreneurship. As discussed in the next chapter, Schumpeter found his home at Harvard less and less in the economics department and more and more in the graduate business school, where he could pursue entrepreneurial studies.[2]

‘Creative Destruction’

“Every piece of business strategy,” Schumpeter famously wrote in 1942, “must be seen in its role in the perennial gale of creative destruction; it cannot be understood irrespective of it or, in fact, on the hypothesis that there is a perennial lull.”[3] During the Great Depression and World War II, when stability and uniformity were sought, Schumpeter’s conception of capitalist progress found little interest. But that changed in the postwar period.

“The Age of Keynes” became “The Age of Schumpeter” as managerial capitalism gave way to entrepreneurial capitalism. His 1942 book, Capitalism, Socialism, and Democracy, would be translated into 15 languages and given many reprintings.

From Schumpeter to Drucker

Business consulting became a thriving new field, helping firms deal with unprecedented change, complexity, and growth. A leading strategist was Peter Drucker, whose book The Age of Discontinuity (1968) described the new reality of the equilibrium-shattering, value-creating entrepreneur.

Drucker (1909–2005) was no trained economist, but he knew that economics had fallen down on the job which it came to emphasizing capitalism’s primer movers. “We need a theory of economic dynamics in addition to the theory of equilibrium, which is all we have now,” he lamented. The “new economics” was dismissed as “static, rather lifeless, and mechanistic.”

Drucker longed for a theory of organizations that took into account what equilibrium analysis assumed away: “scattered” knowledge, new knowledge, expectations, uncertainty, ignorance, technological change, advertising, price adjustments, growth, and product differentiation. “We will have to understand the reality of the market in terms of what it is rather than what it is not,” he told his many readers.

The spirit of Schumpeter (who died in 1950) lived on in Drucker’s above book, although he was hardly mentioned. Drucker would pay tribute elsewhere, however, by calling Schumpeter (in 1983) the figure “who will shape the thinking … on economic theory and economic policy for the rest of this century, if not for the next thirty or fifty years.”

Personality Shades Theory

Schumpeter himself was a revolutionary, writing definitive books and presenting new theories, some wrong, from his twenties until his death at age 67. With a personality as big as his economics, he had to be wrong as well as right. Brilliant, blithe, eclectic, and obsessive, the immaculately attired, aristocratic scholar captured the essence of entrepreneurial capitalism and introduced the terms “creative destruction” and “business strategy.”

And the Wunderkind had a personality to match his professional bona fides. His many exploits and imbroglios made him one of the most colorful of all economists, and certainly the polar opposite of the sedate Adam Smith. He enjoyed taking different sides in a debate and found something to like in just about everything. “Given the choice between being right and being memorable,” remembered colleague John Kenneth Galbraith, “Schumpeter never hesitated.”

Among his students, “Schumpy” was a hit because of his grand presence, masterful scholarship, and personal reminiscences. “I set out to become the greatest lover in Vienna, the greatest horseman in Austria, and the greatest economist in the world,” Schumpeter would fondly recall. “Alas, for the illusions of youth,” he then deadpanned, “as a horseman, I was never really first-rate.” It was as much jest as braggadocio, remembered one student, M. A. Adelman, who was destined to become the dean of energy economics. But if Schumpeter wasn’t the world’s greatest economist in the first half of the century, he certainly came close.[4]

Part II tomorrow will apply Schumpeter’s model to that of Ken Lay at Enron, bringing into the political side of creative destruction.

[1] See the Internet appendix 4.2, Entrepreneurship in Economics: From Unknown to Missing.

[2]“Creative destruction” has become the second most famous phrase in economics next to Adam Smith’s “invisible hand.” The term “business strategy” in the same sentence, which was new, became seminal too.

[3]The darkly romantic side of Schumpeter was illustrated by an experience early in his career when he headed a bank in Vienna. Schumpeter, living extravagantly, was asked by his board of directors to be more discrete in his personal affairs. “In response,” a friend recalled, “he rented a pair-drawn open [carriage] and rode up and down Kärtnerstrasse—a main boulevard in the inner city—at midday with an attractive blonde prostitute on one knee and a brunette on the other.”

[4] Also see Internet appendix 4.3 of Capitalism at Work, “Schumpeter, Drucker, and Hamel.