Schumpeter: The Prophet

We are now living, it is said, in the Age of Schumpeter. The Age of Who? That's economist Joseph Schumpeter (1883-1950). A half century ago, he published his classic "Capitalism, Socialism and Democracy": a book admired by economists, sometimes assigned in college and otherwise unknown. But Schumpeter was a powerful prophet, and he now offers dazzling insights into everything from the rise of Wal-Mart to prosperity's discontents.

He is best known for his evocative phrase "creative destruction." Schumpeter saw capitalism as a system that produces material progress-rising living standards, more creature comforts-through the turmoil of new technologies and business methods. The "entrepreneur," a man of great vision and energy (in his day, there were few women in business), was the driving force of change. Sam Walton and Wal-Mart fit his theory perfectly.

Indeed, Schumpeter's idea of chaotic capitalism seems everywhere confirmed. General Motors is the most visible example of a once dominant company brought to its knees by somebody else's innovation: in GM's case, Japanese carmakers pioneered production techniques that transformed competition in the auto industry. But GM is hardly alone. IBM, long dependent on mainframe computers, is struggling to adapt to personal computers. Sears, Roebuck is assaulted by mass discounters and specialty stores.

It is precisely because the "gale" (his term) of creative destruction seems so ferocious that Schumpeter has enjoyed a revival. But he had a second stunning insight that also is relevant. He argued that capitalism's vast economic success generates popular dissatisfaction with capitalism. As prosperity increases, progress is taken for granted. Capitalism's remaining shortcomings-including the disruption caused by creative destruction-become increasingly intolerable. Finally,, prosperity expands the class of intellectuals who are contemptuous of capitalism.

"[C]apitalism ... creates, educates and subsidizes a vested interest in social unrest," Schumpeter wrote. Popular discontent and intellectual hostility would, he thought, doom capitalism and lead to socialism.

Of course, this prophecy remains unfulfilled. Quite the opposite has happened. By socialism, Schumpeter meant governmental control of production, and societies that adopted that system-from the former Soviet Union to China-are now repudiating it. Though personally opposed to socialism, Schumpeter assumed that socialist societies could prosper because giant economic organizations (whether public or private) would gradually master the process of innovation. The entrepreneur would vanish. On this, he was wrong.

Still, his basic insight survives: capitalist economic success, because it is incomplete and interrupted, breeds its own backlash. The sour public reaction to the present slow economic recovery only highlights a longstanding trend. The growth of Big Government-here, in Europe and in most advanced market societies-has aimed to placate popular discontent without undermining capitalism's ability to raise living standards.

Were he alive, Schumpeter would surely be wondering whether these two desirable goals are incompatible. What we know is that the rise of Big Government-the expansion of welfare spending and regulation-has roughly coincided with a slowdown in economic growth. The trends are clear. Between 1960 and 1989, government spending in the United States rose from 27 to 36 percent of output; in Germany, the increase was from 32 to 46 percent. Meanwhile, economic growth in industrial countries slowed in the 1980s to about half the rate of the 1960s.

But has one caused the other? Have taxes and regulations crippled businesses? Or was the burst of growth in the 20 years after World War II a unique event caused, say, by the pent-up demand left by the war and Great Depression?

Schumpeter would have posed such questions, for he focused on understanding the world, not changing it. This distinguished him from many contemporaries, especially John Maynard Keynes, the century's best-known economist. "I am not running a drugstore," Schumpeter once said. "I have no pills to hand out, no clear-cut solutions for any practical problems that may arise."

In truth, he was something of a loner, as a new biography by sociologist Richard Swedberg makes clear.* Born in the old Austro-Hungarian Empire, Schumpeter was a boy wonder as a young academic but failed in politics (he served briefly as Austrian finance minister) and private banking. In 1926, he was devastated by the death of his second wife, a ravishing beauty 20 years his junior, who died in childbirth after less than a year of marriage. He became despondent and left Austria in 1932 to teach at Harvard. Although he remarried, he never truly got over his grief. His fatalism pervades "Capitalism, Socialism and Democracy."

Its genius is to explain why capitalism succeeds as Adam Smith imagined, even though modern economies lack Smith's perfect competition with hordes of tiny companies. In today's industries, big firms often dominate and enjoy monopoly profits. But most monopolies are temporary, Schumpeter argued. Their high profits, far from stifling competition, inspire more innovation from entrepreneurs and big companies alike. Cable TV assaults the networks; fax machines replace mail; McDonald's invents fast food.

But the drawn-out nature of this process makes capitalism hard to defend politically, Schumpeter said. The argument for it "must rest on long-run considerations." The "unemployed [worker] of today [has] to forget his personal fate and the politician of today his personal ambition." This was not likely.

The dilemma is as real now as when Schumpeter first described it. He is typically rated as the century's second most important economist, behind Keynes. This is correct in the sense that Keynes, through his disciples, influenced countless governments to try to end business cycles. Schumpeter was no reformer, only a scholar bent on unraveling the mysteries of economic life. In that, even Keynes was not his peer. ..L1.- ..MR.-

*"Schumpeter: A Biography" (293 pages. Princeton University Press. $24.95). ..MR0-