June 10, 2000
By Sharon Reier
IT IS A COLD, grim June day in London, but 32 brand-new entrepreneurs are generating some heat as they make 10-minute business presentations in a hotel just off Hyde Park. Their audience: Several hundred venture capitalists who have gathered from three continents and paid $1,800 each to identify the next Bill Gates, or at least the next Jeff Bezos.
Welcome to the vision of Joseph Schumpeter.
Schumpeter was an Austrian-trained economist, economic historian and ardent capitalist who developed a theory with the breadth and grandeur of that of Karl Marx. But where Marx viewed labor as the fundamental unit of economic value and the proletariat as the key agent of change, Schumpeter saw the entrepreneur as the cornerstone of capitalism. Although he died 50 years ago, Schumpeter’s theories anticipated an age when an entrepreneur such as Mr. Gates could command as much global recognition as the president of the United States or the latest rock star.
“Schumpeter would have understood the Bill Gates story perfectly,” said Stanley Metcalfe, director of research at the Center for Research on Innovation and Competition at the University of Manchester, in Manchester, England, and president of the International Schumpeter Society. “He saw the entrepreneur as often facing great hostility.”
Schumpeter’s theory sets forth the idea that the vital force behind capitalism is innovation and the entrepreneur willing to introduce it. A product of the Depression and the economic instabilities that gripped Europe after World War I, Schumpeter also grappled with uncovering the fundamental causes for the business cycle of booms followed by busts. His thesis was that the introduction of innovations was responsible for both the progress and the instabilities of capitalism.
Those instabilities he attributed to the principle of “creative destruction,” a process in which new technologies, new kinds of products, new methods of production and new means of distribution make old ones obsolete, forcing existing companies to quickly adapt to a new environment or fail.
It is an idea that has been seized upon by economists, including central bankers, to explain the remarkable pace of growth, especially in the United States, and to justify the extraordinary gains in the stock market.
If creative destruction allows fast economic growth without generating serious inflation, then it might make sense, for example, to put high values on the shares of companies that will do well in such an unusual environment. It would also behoove governments not to interfere with the prosperity-creating potential of this radical kind of capitalism, even if the destructive elements bring down established companies and lead to job losses.
“Today, nobody can speak about the market society without using these words ‘entrepreneur’ and 'creative destruction,”’ said Manfred Prisching, professor of sociology at the University of Graz in Austria and a former Joseph A. Schumpeter fellow at Harvard University.
Schumpeter himself taught at both the University of Graz and at Harvard University. His extensive writings display a great understanding of all economists before him, but Mr. Prisching said he had departed from mainstream theory, which viewed capitalism and the market as stable.
“Schumpeter believed the static order is disturbed by the entrepreneur, and he investigated where that entrepreneurial spirit came from,” Mr. Prisching said. “He saw it as a different way of looking at the world: The will to create an empire for one’s self. It is a dynamic force that stems from the disposition of some people. Not that they are particularly intelligent. It is not cognitive ability. They are not subtle people. They are often very crude, but they want to attack the world in a certain way. If you take the old adventurers, capitalism turned that into this calculating spirit.”
Whatever their nature, entrepreneurs, by advancing new products, technology or production methods, provide an impulse for change and, in Schumpeter’s words in his 1942 book, “Capitalism, Socialism and Democracy,” “a perennial gale of creative destruction.”
Although overshadowed by the British economist John Maynard Keynes during his lifetime, Schumpeter’s theory and phraseology have become mainstream today for describing the current era, in which new-economy companies are being created at an astounding rate. No less an establishment figure as Alan Greenspan, chairman of the U.S. Federal Reserve Board and a Harvard-trained economist, has been using Schumpeterian economics to explain the remarkable noninflationary expansion in the United States over the past eight years.
Testifying before the Joint Economic Committee of Congress a year ago, Mr. Greenspan said the “evident acceleration of the process of creative destruction, which has accompanied these expanding innovations and which has been reflected in the shifting of capital from failing technologies into those technologies at the cutting edge, has been remarkable.”
The innovations Mr. Greenspan was describing included the microprocessor, the laser, fiber optics and satellite technologies. But he added: “The innovations in information technology — so called IT — have begun to alter the manner in which we do business and create value, often in ways that were not readily foreseeable even five years ago. As this century comes to an end, the defining characteristic of the current wave of technology is the role of information.”
Nor is the wave of innovation limited to new-economy companies. Mr. Greenspan explained that established industries had been adapting the new technologies to enhance their productivity.
“Our century-old motor vehicle industry, for example, has raised output per hour by a dramatic 4.5 percent annually on average in the past two years, compared with a lackluster 1.5 percent on average earlier this decade,” he said. “Much the same is true of many mature industries such as steel, textiles and other stalwarts of an earlier age.”
In these messages, Mr. Greenspan seems to be affirming the answer to a puzzle over which he had brooded several years before.
“We do not know,” he then stated, “nor do I suspect anyone can know, whether current developments are part of a once-or-twice-in-a-century phenomenon that will carry productivity trends nationally and globally to a new higher track, or whether we are merely observing some unusual variations.”
The idea of major advances occurring every 50 or 100 years echoes Schumpeter’s analysis of economic cycles. He conceived of capitalism’s restless history as punctuated by long and short waves. A long upswing is stimulated when a new set of technologies and industries comes into existence.
Schumpeter wrote that the boom in the early 19th century had been ignited by the rise of textiles, iron, coal and steam engines. The expansion in the mid-19th century, he said, was related to steel production and the construction of railroads, and the early-20th-century boom was driven by automobiles, electric power and associated products.
Schumpeter often used the example of the railroad as a powerful transforming agent in the economy, opening up opportunities while clearing out old areas of activity and ways of behaving. As railroads spread across the United States and freight rates fell to 2 to 3 cents per ton mile, he noted, the old canal and turnpike system suffered to the point of extinction. On the social front, the railroad companies paved the way for the settlement of the Midwest and West, often building grain elevators and preparing many things for would-be farmers.
Schumpeter’s booms, however, “contain seeds of their own destruction,” said Paul Stoneman, head of the Technological Innovation Research Unit at the University of Warwick in England.
“The entrepreneur brings along something new,” he said. “That’s the source of profit. Others come into the market and whittle the profit away. As they copy, you get more investment. You get changes in investment. You get changes in profit. It starts a speculation cycle. Lots of people speculate on the markets and the market starts to boom. But it has to evaporate.”
“Eventually,” he added, “whatever started the boom, everyone has it. Once everyone has a car, there is only replacement demand. Once everyone has Internet access, they stop buying machines to access them.”
Defenders of Mr. Gates and Microsoft Corp. like to cite Schumpeter’s theories on monopoly. Schumpeter believed there was nothing wrong with monopolies and that they could be more effective purveyors of innovation than many start-ups.
“You tend to get a monopoly position because you are very good,” Mr. Metcalfe said. “Schumpeter certainly believed that you should judge monopolies by their innovation record, not by whether or not it has monopoly profits.”
“But the important point is that as long as there are open markets, he sees all monopolies as transient,” he added. “Capitalism is restless, and somewhere in California, there is a young kid plotting Bill Gates’s downfall.”
If Schumpeter got something wrong, it was in his vision of capitalism’s endgame. He predicted that capitalism would become bureaucratic, squeezing out the individual entrepreneur and making innovation routine and subject to centralized management.
So far, the evidence points against this hypothesis. If anything, capitalism and entrepreneurialism are spreading. Even in South Korea, long dominated by huge bureaucratic conglomerates, entrepreneurs and venture capitalists are emerging as heroes.
“There are now about 6,000 official start-ups in South Korea,” said Young Han, a member of the Samsung Global Strategist Group, who was attending the entrepreneur’s meeting in London in the hope of finding new European firms that Samsung might want to back. “All the young people are crazy about start-up companies. We now have 140 venture-capital companies where we had two dozen a few years ago.”
Asked Mr. Han: “Do you know who is now one of the heroes in Korea? Masayoshi Son, the CEO of Softbank. His company is in Japan, but his origins are Korean.”
Schumpeter would no doubt have been delighted.
For more information:
INTERNATIONAL JOSEPH A. SCHUMPETER SOCIETY. www.wiso.uni-augsburg.de/vwl/hanusch/iss/index.html
BOOKS BY JOSEPH SCHUMPETER
Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process (Porcupine Press)
Capitalism, Socialism and Democracy (Harper Torchbooks)
History of Economic Analysis (with Elizabeth Boody, Oxford University Press)