Joseph Schumpeter

Joseph Alois Schumpeter (1883 - 1950) was an economist and one of the 20th century's greatest intellectuals. He is best known for his 1942 book “Capitalism, Socialism, and Democracy,” as well as the theory of dynamic economic growth known as “creative destruction.” He is also credited with the first German and English references to “methodological individualism” in economics.

Schumpeter was born in Austria in 1883 and learned economics from the progenitors of the Austrian school tradition, including Friedrich von Wieser and Eugen von Bohm-Bawerk. Over his many years in public life, Schumpeter developed informal rivalries with the other great thinkers of the west, including John Maynard Keynes, Irving Fisher, Ludwig von Mises and F.A. Hayek. Schumpeter moved to the United States in 1932 to teach at Harvard, and in 1947, became the first immigrant to be elected president of the American Economic Association.

Schumpeter made many contributions to economic science and political theory, but by far his most enduring legacy came from a six-page chapter in “Capitalism, Socialism, and Democracy” entitled “The Process of Creative Destruction.”

“The same process of industrial mutation — if I may use that biological term — that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of creative destruction is the essential fact about capitalism.” (pg. 83)

This was a penetrating and unique insight about how economies grow. Schumpeter explained economic progress is not gradual and peaceful but rather disjointed and sometimes unpleasant. Whenever an entrepreneur disrupts an existing industry, it is likely that existing workers, businesses or even entire sectors can be temporarily thrown into loss. These cycles are tolerated, he explained, because it allows resources to be freed up for other, more productive uses.

By the early 20th century, economic science in the United States and Great Britain had developed along static and mathematically oriented general equilibrium models. In Continental Europe, German and Austrian economists took a more nuanced and less hypothetical approach. Schumpeter’s creative destruction typified the Continental version, although much of his other work was drawn from Walrasian general equilibrium.

Schumpeter’s arguments sharply deviated from the dominant tradition in many other respects. First, he highlighted the fact that markets do not passively tend toward equilibrium until profit margins are wiped out. Instead, entrepreneurial innovation and experimentation constantly destroy the old and introduce new equilibria, making possible higher standards of living.

In many respects, Schumpeter saw capitalism as a method of evolution within the social and economic hierarchy. The entrepreneur becomes the revolutionary, upsetting the established order to create dynamic change. Much of Schumpeter’s analysis of entrepreneurism was developed in his 1911 “Theory of Economic Development."

Schumpeter’s concept of “methodological individualism” eventually became a pillar of neoclassical analysis and, in particular, the Austrian School of economics. In his early career, Schumpeter derided the use of statistical aggregates in economic theory, likely a shot at Keynes, in favor of focusing on individual choice and action.