It’s Love “Schumpi” Day

When last I wrote here I repeated a quote by Joseph Schumpeter, that Paul Krugman used to lambast the classical opposition to government interference in the economy.

True to form, I was immediately set upon by the one man Austrian economist defense force – Stephan – who managed to dig out the original text from which the quote was cut. His purpose being to draw my attention to the softer tones used elsewhere in that document.

I agree. Schumpeter was not as clear cut a terror as Krugman made him out to be. While we all know Schumpeter as the inventor of the phrase: “the gales of creative destruction of capitalism”, he was so much more.

His influence was muted by the fact that his long career always seemed to leave him out of the limelight, he was eclipsed by Keynes for instance, and never part of a dominant school of thought. He was a teacher, at Harvard, of a number of subsequent “Nobel” prize winners, but his books and papers put him outside of the emerging mainstream of American economic theory.

In many ways Keynes was more orthodox than Schumpeter.For instance, Keynes, for all his rebellion against classical theory, was still committed to static equilibrium style thinking. That in his system equilibrium could imply less than full employment was startling, and controversial. But his thinking was focused on the properties of economies as they tend toward or away from such equilibrium. It was Patinkin who pointed out that Keyne’s great innovation was to locate the equilibrating force within his novel conception of “effective demand”. Everything else in The General Theory flows from that idea, and the tools Keynes used were borrowed and adapted from others, such as theeconomist Fisher.

By contrast, Schumpeter was never interested in equilibrium. He saw the economy as in perpetual flux and never in the kind of static equilibrium that has come to dominate orthodox economics since the mid-20th century. This is why he was led to discuss “creative destruction”. The central actor in his conception of an economy was the capitalist innovator driven by profit to search for new products and new methods of production. It was this innovation that, in Schumpeter’s view, provided the engine driving wealth creation and social welfare generally. Along the way capitalists make mistakes, they over produce or over invest, this leads to periods of adjustment and the need to revalue assets. These periods are what we call recessions or depressions, and are the times when those mistakes are wiped away. Hence the destruction. Naturally once the adjustment has been made and past mistakes expunged, the now chastened capitalist class powers forward again, driven once more by the profit motive, only this time free of the encumbrance either over valued assets or ill advised investments. Hence the creative aspect to Schumpeterian economics.

Drucker draws the difference between Schumpeter and Keynes nicely. Keynes, he said was merely a heretic. Schumpeter was a full blown infidel.

Unfortunately for Schumpeter his notion of an economy being dynamic and subject to cyclical upheaval flew directly in the face of classical theory whose goal was to place economics firmly into a Newtonian firmament both mechanical and determinist. This misfortune was compounded by the success of people like Arrow and Debreu who, a few years after Schumpeter’s death, were able to create the mathematics necessary to articulate a model of general equilibrium and thus obviate the need for younger theorists to explore the seeming chaos of the Schumpeterian world.

Oddly, sixty years after his death, Schumpeter seems more relevant than before. His ideas could be re-cast as being evolutionary, and the great theme of evolution is one possible way in which economics can regain the relevance and connection with reality it lost after Arrow-Debreu. His importance to current events is even more significant when we consider his long view for capitalism. It was a system, he thought, that would choke itself on its own success. Not through the results posited in the Marxist critique, but because of something altogether more mundane: he feared that capitalism would spawn a great bureaucracy populated by elitist “hangers-on” to the entrepreneurial machine. These elitists would be highly educated workers like lawyers, accountants, and bankers who would eventually sap the system of its vitality through their ability to impose non-productive costs on the innovative process. They would rent seek, draw off funds, and starve capitalists of the means to keep the engine running.

This scenario sounds eerily familiar. It also accords with the work of a protege of his nemesis. It was Minsky, a follower of Keynes, who correctly developed a theory describing the instability within finance – one of Schumpeter’s feared bureaucracies. So, perhaps, within a Minsky moment we can detect the imprint of Schumpeterian creative destruction.

If so, there is hope for a conjunction of the theories of two of greatest non-classical thinkers of twentieth century economics.

And we need all the new ideas we can get.