Joseph Alois Schumpeter (1883-1950) was an Austrian-trained economist, economic historian, and author. He is regarded as one of the 20^th century's greatest intellectuals. Schumpeter is best known for his theories on business cycles and the development of capitalist economies, and for introducing the concept of entrepreneurship. For Schumpeter, the entrepreneur was the cornerstone of capitalism—the source of innovation, which is the vital force driving a capitalist economy.

Early Life and Education

Schumpeter was born in Moravia (now the Czech Republic) in 1883, to German parents. He studied economics from the progenitors of the Austrian school tradition, including Friedrich von Wieser and Eugen von Bohm-Bawerk. Schumpeter served as minister of finance in the Austrian government, the president of a private bank, and a university professor. From 1925 to 1932, Schumpeter held a chair at the University of Bonn.

Uncomfortable at the rise of the Nazi Party, he moved to the United States to teach at Harvard in 1932. Fifteen years later, in 1947, he became the first immigrant to be elected president of the American Economic Association.

By the early 20th century, economic science in the United States and Great Britain had developed alongside static and mathematically oriented general equilibrium models. Schumpeter’s work differed at times, typifying the continental European approach—more nuanced and less hypothetical—although some of his theories were drawn from Walrasian general equilibrium as well.

Notable Accomplishments and Theories

Schumpeter made many contributions to economic science and political theory, but he is best known for his 1942 book Capitalism, Socialism, and Democracy, which outlines 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.

Creative Destruction

Schumpeter's most enduring legacy came from a six-page chapter in Capitalism, Socialism, and Democracy entitled “The Process of Creative Destruction.”

In this chapter, Schumpeter offered a new, unique insight into how economies grow, sharply deviating from the traditional economic dictums of his day, which held that markets passively tend toward equilibrium until profit margins are wiped out. Instead, Schumpeter argued, economic progress is not gradual and peaceful but rather disjointed, abrupt, and sometimes unpleasant. The economist used the term "creative destruction" to describe the dismantling of long-standing practices in order to make way for new technologies, new kinds of products, new methods of production, and new means of distribution.

Existing companies must quickly adapt to a new environment (or fail). If it sounds somewhat Darwinian—it is, Schumpeter intimated: a "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," as he wrote. "This
process of creative destruction is the essential fact about capitalism.”

Entrepreneurship

In many respects, Schumpeter saw capitalism as a sort of ongoing revolution that disrupts the current social and economic hierarchy. And within this system, the entrepreneur becomes the revolutionary, upsetting the established order to create dynamic change.

Schumpeter is believed to be the first scholar to introduce the world to the concept—or at least, the economic significance of—entrepreneurship. He came up with the German word Unternehmergeist, meaning entrepreneur-spirit, adding that these individuals controlled the economy because they are responsible for delivering innovation and technological change.

Entrepreneurs are often the guiding force behind creative destruction because they advance the new products, technology, and/or production methods that provide an impulse for change. Entrepreneurial innovation and experimentation constantly destroy the status quo and introduce new equilibria, making possible higher standards of living.

Business Cycles

These theories tie in with Schumpeter’s belief in the presence of business cycles.

In Schumpeter's analysis, the history of capitalism has been punctuated by long and short waves. A long wave is prompted by a new set of technologies and industries coming into existence. According to this theory, major advances in innovation can be predicted to occur every 50 or 100 years.

"Barring very few cases in which difficulties arise, it is possible to count off, historically as well as statistically, six Juglars [8-10-year business cycles] to a Kondratieff [50-60 years] and three Kitchins [40 months] to a Juglar—not as an average but in every individual case,” wrote Schumpeter in his book The Theory of Economic Development, published in 1911.

Whenever an entrepreneur disrupts an existing industry, it is likely that existing workers, businesses, or even entire sectors can be temporarily thrown into loss, he said. These cycles are tolerated, he explained, because it allows resources to be freed up for other, more productive uses.

Example of Schumpetarian Theory

The internet is one of the best examples of creative destruction, the term that Schumpeter coined to describe the dismantling of long-standing practices in order to make way for new technologies, new kinds of products, new methods of production, and new means of distribution. Existing companies must quickly adapt to a new environment (or fail). The advent of the Internet rendered many products, methods of production, and means of distribution obsolete. It also caused a drastic curtailing of many jobs, including the roles of bank tellers, secretaries, travel agents, and retail store employees. With the rise of mobile internet technology, publishers of printed material—everything from magazines to maps—also suffered. The Internet, in addition to other innovations in the field of information technology—the microprocessor, the laser, fiber optics, and satellite technologies—have all fundamentally altered the way that business is conducted.

Joseph Schumpeter vs. John Maynard Keynes

Over his many years in public life, Schumpeter developed informal rivalries with the other great economic thinkers of the west, including John Maynard Keynes, Irving Fisher, Ludwig von Mises, and Friedrich Hayek. His work initially was overshadowed by some of these contemporaries', especially Keynes. Although they were born just a few months apart, the pair had radically different views.

Keynes viewed the economy as healthy when in static equilibrium. Schumpeter rejected this theory, claiming that equilibrium is not healthy and that innovation is the driver of the economy. Both had contrasting views on government intervention, too. Keynes believed that a permanent equilibrium of prosperity could be achieved by central bank monetary policies. Schumpeter argued that government intervention increased inflation, destroying the economy.

The internet is one of the best examples of creative destruction, the term that Schumpeter coined to describe the dismantling of long-standing practices in order to make way for new technologies, new kinds of products, new methods of production, and new means of distribution. Existing companies must quickly adapt to a new environment (or fail). The advent of the Internet rendered many products, methods of production, and means of distribution obsolete. It also caused a drastic curtailing of many jobs, including the roles of bank tellers, secretaries, travel agents, and retail store employees. With the rise of mobile internet technology, publishers of printed material—everything from magazines to maps—also suffered. The Internet, in addition to other innovations in the field of information technology—the microprocessor, the laser, fiber optics, and satellite technologies—have all fundamentally altered the way that business is conducted.

The Bottom Line

Joseph Schumpeter’s work initially received little acclaim, due in part to the great popularity of his contemporary, John Maynard Keynes. That changed over time and he is now viewed as one of the greatest economists of modern times. He introduced the concept of the entrepreneur and the influence of entrepreneurship on economic systems. His theory of creative destruction has become the centerpiece for modern thinking on how economies evolve—especially capitalist ones.