A contemporary of Keynes, Joseph Alois Schumpeter was a native of Austria, born of solid, yet undistinguished stock. Educated amid the upper crust at an exclusive school, he developed elitist airs that followed him throughout his life. From being a brainy enfant terrible who challenged his teacher at the University of Vienna, he moved to England, where he served successfully as a financial adviser to an Egyptian princess. While in her employ, the twenty-seven-year-old Schumpeter published The Theory of Economic Development (1912), an unassuming overview of capitalistic growth. Surprisingly, the book describes a capitalist economy which lacks accumulation of capital. Relying on a circular flow, the model, like a toy train maneuvering around a hearthside track, remains static and predictable, never altering or expanding.
In answer to the age-old stumper of where profits originate, Schumpeter declares that capitalism, grounded in inertia, has no momentum. Workers, he predicted, would, in time, receive full remuneration for their toil while owners will derive value equivalent only to the resources they contributed. Capitalists would obtain nothing except their wages as managers. Thus, in a changeless economy, profit does not exist.
As Schumpeter elaborates, the only explanation for profits occurs when the static economy fails to follow its circular path, a situation which occurs when capitalists introduce innovative technology or organizational changes. Such ephemeral profit disappears after competitors emulate the innovation. In rapid order, innovation becomes the standard operating procedure. Like a huge, insatiable maw, the system swallows up ideas, turning them into the well-digested fuel of everyday productivity. Because the introducers of these changes differ from the norm, Schumpeter awards them the title of entrepreneur, one who is a business trailblazer, or risk-taker.
An additional surmise of Schumpeter's Theory of Economic Development is his explanation of the business cycle. As a swarm of imitators follows the trail blazed by the business pioneer, investment spending leads to a short-lived economic boom. Competition, as always, forces prices down. Ultimately, profits disappear. Ironically, the entrepreneur is not necessarily the receiver of the profit generated by an innovative idea. As a rule, profits tend to go to the business owner, with the entrepreneur forced out of the picture by the dynamics of the new process.
Schumpeter paints an unappealing picture of the life of an entrepreneur—a talented specialist who differs markedly from the military leader or politician. Treated by society as an upstart or social pariah, the entrepreneur resides outside the limelight. Unlike people who are motivated by the urge for riches or title, the entrepreneur prefers instead to found a dynasty. Goaded by the will to conquer, to climb to the top of the heap, this creator resembles a paladin, or "knight errant of the system." For the entrepreneur, the carrot at the end of the stick is not the monetary reward but the challenge itself, the vacuum into which innovation falls.
After the publication of his ingenious work, Schumpeter served as commissioner on the nationalization of industry, an arm of the socialist German government, as well as finance minister of Austria.
Unfortunately, the unstable times did not permit his creative beacon to shine very far. After Schumpeter moved into a position as bank president in Vienna, the collapse of Europe's financial structure led to huge personal debts. During this trying period, Schumpeter's young and charming wife, whom he had groomed for her role as his helpmeet, died in childbirth.
Like the fabled phoenix, Schumpeter rebounded. He built a career as a visiting professor in Japan, Germany, and the United States. At Harvard, he married economist Elizabeth Boody. Renewed, he allowed his creative juices to flow at will.
In his thousand-page, two-volume Business Cycles, Schumpeter attempted to account for the Great Depression. He based his explanation on a description of three distinct types of business cycles:
1. A short cycle.
2. A second span lasting 7-11 years.
3. A fifty-year cycle evolving from blockbuster inventions like the steam engine or automobile.
The Great Depression, which stands out from the norm of economic ups and downs, was the cataclysm that erupted when a series of all three cycles hit bottom simultaneously.
Schumpeter's conclusion produced a major economic contribution: the belief that capitalism, which evolves from the values of the civilization itself, was losing its steam. Even though his prediction emphasizes a moribund state of the economy, the author appends a small hope that there are still three decades in which capitalism will struggle before dying out completely.
A more complete economic vision appears in Schumpeter's Capitalism, Socialism, and Democracy (1942), in which the author mounts an offensive thrust against his arch-enemy, Karl Marx. Departing from his predecessor's obsession with the antagonism between capitalist and worker, Schumpeter fastens onto the bourgeois nature of the capitalist. Crucial to his denouncement of the wearer of the lounging suit is the author's depiction of plausible capitalism, which describes capitalism as an economic success but a sociological failure. The system bogs down in a bureaucratic nightmare of red tape, where entrepreneurial input counts for little. Yet, even though Schumpeter's scenario plays well on the surface, it is riddled by the disease of rationalism, which gobbles up its own reason for being.
Schumpeter, from the vantage point of his cleverly constructed soapbox, appears to defeat Marx at his own game. The whole breastwork of logic carries some measure of significance in that it predicts the bureaucratization of business and government as well as the ebb and ultimate foundering of the middle-class ideal. Still, the fabric of his logic is weakened in fiber. The mood of Western capitalism did indeed follow his predicted trends through the 1960s. However, it has not resigned itself to the benign socialism he envisioned.
The overwhelming weakness of "the world according to Schumpeter" is that the prognosis is more social and political than economic. In guessing which way the tide of history will direct itself, he lends credence to a belief in a noncapitalist elite, who will form the dynamic core of an otherwise inert society. Unlike Marx's paradigm, which centralizes a disgruntled proletariat in the heart of change, Schumpeter's model places a changing cast of creative movers and shakers at the lead position of capitalistic innovation.
