Schumpeter the Superior

The greatest horseman in Vienna, the greatest lover in Austria, the greatest economist in the world. This, Joseph Schumpeter used to say, is what he’d set out to be. In one of them, he added, he’d failed. But he never said which. A horse, almost certainly, had let him down. He had a slightly lopsided walk, the result, it was said, of a fall. About women, there is less doubt.

His mother’s marriage to a retired general in 1893, when he was ten, got him into the best school in Vienna and gave him a taste for expensive society. His first wife, improbably for such a high-living and affectedly heroic young man, whose outlook on the world owed not a little to Nietzsche, was the daughter of a dignitary of the Church of England. She was older than he, was said to be ‘stunning’, and was perhaps rebelling. They married in 1907, and were together for two months. His second, Anna Reisinger, was much younger. She was the daughter of the caretaker of his mother’s house in Vienna. He started to see her in 1920. But he remained ostentatiously wild, and she resented his style. In the early Twenties, the board of the bank he chaired in Vienna asked him to be more discreet. He responded by hiring an open carriage and two prostitutes and trotting up and down the Kärtnerstrasse with one on each knee. He and Anna did not marry until 1925. Within a year, however, she died, in childbirth, together with the child. Schumpeter was devastated. She had, he said later, been ‘the great wonder of my life’. His mother had died a few weeks before, and he continued to talk to the two women in his diaries for the rest of his life. He had affairs again at Harvard, where he went in 1932. But he came to agree with Elizabeth Boody, an economic historian whom he met there soon after he arrived, that he’d come to lead ‘a ridiculous life’. In 1937, they married, and she sustained him. He died in her country house in Connecticut in 1950.

As an economist, his reputation has always been more ambiguous. His most famous book, and his greatest. Capitalism, Socialism and Democracy (1942), was one – J.K. Galbraith told Richard Swedberg – that he himself disdained. It was too popular. His first, which he wrote in 1908, when he was 25, irritated the historical economists, who dominated the subject in Austria, with its defence of the new marginalism. His second, The Theory of Economic Development, which was published in 1911 and made his name, irritated the marginalists, who had taught him, with its enthusiasm for Marx. The most technical, Business Cycles, which he worked on at Harvard, was later described by Paul Samuelson, whom Schumpeter had thought the cleverest of the students there, as ‘Pythagorean moonshine’. Yet in 1940, Schumpeter succeeded to the presidency of the Econometrics Society and in 1949 became the first president of the International Economic Association. In his last book, an unfinished history of economic thought which Elizabeth put together after he died, he said that all the great economists had had a distinctive ‘vision’. It is for his own, more than any precise contribution, that he is remembered.

Swedberg describes it as a grand synthesis – a Sozialökonomik, as it was called in Vienna before 1914 – in which general theory would somehow be combined with economic history and a sociology. Schumpeter did envisage such a thing. But he was ambivalent about it. Marx’s mistake, he used to say, was to have made his sociology do too much work for his economics, and vice versa. It was Walras, specifying the equations for general equilibrium, who had put his finger on ‘the fundamental problem’ of economics. Nonetheless, Schumpeter seems to have intended Business Cycles to be his own economic theory, supported by statistics, and Capitalism, Socialism and Democracy his sociology and politics. Richard Swedberg, a sociologist in Stockholm, favours Sozialökonomik, and is impatient with abstract reasoning. He’s writing in a second language, and his publishers have done him no service by leaving him unedited. But he has done original research, and gives a full and careful picture of his complex subject. Eduard März, who studied at Harvard, is better on the economics and explains the economic history of Austria-Hungary, which affected Schumpeter’s early thinking. (He first published this collection of essays in German and extended and revised them in English before his death in 1987.) But it’s clear from Swedberg’s detail that März is sometimes inaccurate on the life, and he devotes much space to defending Marxists. Neither says as much as one would like about Schumpeter’s politics.

These illuminate his vision. Yet they can seem contradictory. ‘For all his tone of objectivity,’ Samuelson remarked, ‘Schumpeter was a reactionary’ – ‘but as Holmes said of Spengler, he is the kind of rascal who gives you a run for your money.’ This is the view of the generation that Schumpeter taught at Harvard, the view of those who took popular democracy for granted, were enthused by the New Deal, and were attracted to Keynes. And it’s not without foundation. ‘Humanity does not really care for freedom,’ Schumpeter remarked in one of the aphorisms that he used to scribble in his Cambridge diary or on the small slips of paper which he carried with him, and which Swedberg reproduces at the end of his book: ‘the mass of the people quickly realise that they are not up to it. What they want is being fed, led, amused and, above everything else, drilled. But they do care for the phrase.’ ‘Equality is the idea of the subnormal, but even the subnormals do not really desire equality, only that there be nobody better.’ ‘There is not only one enemy of humanity – the subnormal – there is another, the idealist.’ ‘Democracy is government by lying.’ ‘The first value in life is victory, the second is revenge.’ But of course, ‘we do all like a sparkling error better than a trivial truth.’ He caused Max Weber to storm out of a coffee-house in Vienna in 1919 by saying that he welcomed the revolution in Russia. Weber insisted that it would lead to unparalleled misery and end in catastrophe. ‘Quite likely,’ replied Schumpeter, ‘but what a fine laboratory.’

In 1919, and for just this reason, Schumpeter was in favour of putting industry under public control. Those who knew his previous views, that capitalism was the dynamic force, and that what he’d called a ‘Tory democracy’ of the British kind would be best for Austria, were surprised. ‘I don’t know whether or not socialism is a practical possibility,’ he explained to a colleague on a Socialisation Commission, ‘but I’m convinced that it’s impossible if not applied integrally. At any rate, it will be an interesting experiment to try it out.’ The commission, which had been set up by the Socialists in Berlin, produced its first report in February 1919. In the same month, there were elections in Austria, and Karl Renner formed a coalition of Social Democrats and members of the Christian Social Party. Otto Bauer, a Social Democrat, was given the ministry of foreign affairs, and asked that Schumpeter should have finance. Another pragmatic Marxist, Rudolf Hilferding, had recommended him; Bauer himself was impressed by Schumpeter’s support for socialisation, which, as Bauer saw it, should consist in firms run by boards on which producers and consumers as well as the state would sit; and Renner no doubt thought that Schumpeter would be acceptable to the conservative Christians. But Schumpeter was suspicious of Bauer’s plan for an Anschluss with Germany, and quickly realised that Austria needed foreign investment, which would be deterred by any change in property rights. He had also proposed a domestic capital levy, which went down poorly with the small farmers on whose support the Christians depended. The Cabinet rejected his financial plan, and he was dismissed. He’d lasted seven months.

Schumpeter nevertheless continued to explain the advantages of socialism. In Capitalism, Socialism and Democracy, he did so at length, suggesting that this was the direction in which modern economies were going anyway, and that socialism could eliminate cyclical fluctuations, produce an optimum rate of technical change, and ensure full employment. He didn’t welcome it, but if it was led by honest and ambitious men, with no nonsense about popular participation, it might work. There was certainly no reason to expect any disappearance of ‘the impulse to fight, to prove oneself superior to others, to succeed for the sake, not of the fruits of success, but of success itself’ – the impulse, he believed, which had created modern capitalism. ‘A decent bureaucracy may always be relied upon to bring all its members up to its standard.’ But ‘this says nothing about what this standard itself will be. That possible superiorities might in practice turn into actual inferiorities must be kept in mind throughout.’ There was no contradiction. In politics and economics, right or left, it was efficiency, drive, élan – superiority – that mattered most.

Capitalism itself, he’d argued in Development, was not new. But for centuries, it had been static. Producers recouped their costs as ‘wages’ in sales, and consumers spent all they earned. There was no profit, no savings, no need for credit, and no interest. Some producers might gain a small advantage, and creep ahead. But the others would always catch up with them, costs would rise with the demand for producers’ goods, and the system would return to stasis. What served to change it, he argued, was bank credit. This enabled innovators to expand and make fresh investments. Old habit was broken, and growth began. This would not, it was true, be smooth. There would be cycles. Interest rates would rise, and because money would exceed the supply of goods, there would be inflation; some firms would go bankrupt, and there would be recessions. But growth would recover. As it proceeds, he was later to point out, managers succeed the creative entrepreneurs, big firms are able to finance themselves, and monopolies emerge. This is the point at which it makes sense to step from capitalism to socialism.

Schumpeter’s arguments in Development, as März explains, caused as much puzzlement as his polities. He claimed that he started with the marginalists and ended near the Marxists. Neither were persuaded. Eugen von Bohm-Bawerk, a marginalist who’d taught Schumpeter in Vienna, argued that even in the static state, there is profit. Firms produce more than is presently required, and create stocks for the future. But Schumpeter couldn’t see how in a static system, the value of additional stocks could actually be realised. Nor was he happy with the Marxist argument that value was realised from labour. Why shouldn’t competition drive exploitation down? Nonetheless, the Marxists had a theory of dynamics, which, he insisted, the marginalists did not. And although they tied their economics to a sociology, and thereby underrated the importance of the individual entrepreneur, some Marxists in Austria itself, like Hilferding, had come to see the importance of banks.

Schumpeter wrote Development in Czernowitz – Chernovtsy in what is now the Ukraine – at the eastern end of the empire. (He would recall that the demands on him there were few. There was time for girls, and even for a bit of old-fashioned university politics: he fought a duel with the librarian to improve the students’ access to books, and won.) Bohm-Bawerk got him a better job, at Graz in 1911, which he kept for ten years. But after Vienna, and power, Graz was boring. On his dismissal from the Cabinet, the Assembly had granted him a concession to form a bank: he decided to use it to bargain for the chairmanship of the Biedermann. He was not a success, in style or in substance, and in 1924, was asked to leave. He decided to return to economics, and took a chair at Bonn. He did succeed in this, but he’d lost his investments, and the death the next year of his mother and new wife and child made him restless. He took the opportunity to escape twice to Harvard. F.W. Taussig, the grand old man of economics there, had been interested in what he’d had to say about entrepreneurship. The rest of the department knew that they needed new thinking, were attracted by his experience as a minister, and liked him. Having been turned down by the Humboldt University in Berlin, largely because of his debts, he accepted Harvard’s invitation to go there for good.

He was in every sense a smart addition. The students would marvel at and monitor his range of matching outfits. ‘The cycle was not simple,’ observed Samuelson’s wife, ‘and far from random.’ He revived the teaching of theory, and with more enthusiasm, he agreed, than skill, promoted the new mathematical and statistical methods. But external events and changes within economics itself soon served to estrange him. He refused to believe that the Depression was anything more than one of the temporary downswings he’d defined in Development. There might be a case for some emergency public spending. But there was no justification for the ‘dictatorship’ of the Democrats’ new ‘tax state’. He also thought that Roosevelt would take the United States into the coming war in Europe. (‘My dear lady,’ he replied to a woman at a party in 1944 who’d asked whether he favoured the President’s reelection, ‘if Hitler runs for President and Stalin for Vice-President, I shall be happy to vote for that ticket against Roosevelt.’) Although he did in fact detest Hitler – he actively helped Jews to settle in the United States – he took the view that Germany’s aggression, given Versailles, was understandable. He also thought that Hitler might win the war. He knew of Japan’s industrialisation from a visit in the early Thirties and from Elizabeth’s research, and admired it. And he would repeatedly warn against the Soviet Union.

The best of the Harvard graduates were convinced that the new mathematical methods would enable them to give precision to the idea of an economic system and determine relations within it. They believed that the Depression was more than a cyclical turn; it required structural adjustment. And they had gone into economics to do some good. When Keynes’s General Theory arrived in 1936, therefore, many of them fell on it, and used the new methods to sec where it could lead. Schumpeter, meanwhile, was spelling out his theory in Development, that capitalism’s progress could be captured in the history of its cycles, short, medium and long, which moved together, and that these could be shown to depend on innovations. Business Cycles appeared in 1939. It was not the moment, what with the enthusiasm for Keynes, to be pressing supply-side factors; other economists at Harvard, following Jan Tinbergen’s lead, were modelling cycles as inherent in the system, not caused by ‘exogenous shocks’, such as innovations; and Simon Kuznets showed that even on its own terms, Schumpeter’s argument did not stand up. Innovations don’t, as he claimed, come in bundles; cycles don’t always complete the circle of prosperity, recession, depression and recovery; and they rarely move together.

Business Cycles deliberately ignored institutions. Schumpeter turned to consider them in Capitalism, Socialism and Democracy. Monopoly capitalism, he said, was the new agent of innovation. It had the resources, and the power to deploy them. He saw no conclusive reason to believe that the socialism which might succeed it could not be just as effective. (In this, he underrated the efficiency with which market prices convey information, and seems to have been innocent of the argument which Hayek had made in the late Thirties against Oskar Lange: that an ‘integral’ socialism would mean ‘a system composed of hundreds of thousands of equations, with hundreds of thousands of unknown quantities, the underlying assumption being always that the latest data are used.’ And Hayek had himself been too sanguine. It’s said that by the early Eighties, Soviet planners were having to cope with 10,000,000,000,000 bits of often false information.) Socialism could also, Schumpeter argued, be democratic. Liberals and Marxists were wrong to believe that certain kinds of politics could only go with certain kinds of economic arrangement. Factions of the political class could always compete for votes.

In 1943, Joan Robinson said that the book was ‘worth the whole parrothouse of contemporary orthodoxies, right, left or centre’. It can still excite. Schumpeter’s theory of democracy, although silent about rights and justice, remains persuasive. And the supply side of the economy is, in the end, the more important. Large firms, it’s been shown, do often innovate. If one follows Schumpeter’s later extensions of the idea of entrepreneurship, accepts his argument for the role of credit, and takes due account of the internationalisation of both finance and trade, one has an explanation of the most successful capitalisms of the past thirty years. Actually existing socialisms have been less impressive. Schumpeter would have now to concede that, ‘applied integrally’, the experiments have failed. But he might add that whether total or partial, they’ve not been helped by the fact that Marxists and what he once called ‘bloodstained mongol despots’ have been in charge of them in the East, and Keynesians in the West.