He Spoke Out For Capitalism

• David Saito-Chung
• On 6:10 pm EST, Monday November 9, 2009

In 1909, Joseph Schumpeter and a college librarian argued over access to books for students.

To settle their dispute, they agreed to a duel.

Schumpeter, the flamboyant young professor at the University of Czernowitz on the outskirts of the Austro-Hungarian Empire, and the librarian met on the field one morning and began to fight.

Schumpeter, who had fenced as a student at the University of Vienna, drew blood first with a slice into the librarian's shoulder.

Their seconds quickly stopped the duel. Schumpeter won his students' access to books. He and the librarian later became friends.

Schumpeter's passion for learning also ran deep in his writings and teaching about how capitalism works and why industrial societies thrive. He became a champion for free markets when the world was a giant stage between the dueling systems of communism and capitalism.

Among scholars who sided with capitalism, England's Adam Smith argued for free trade. John Maynard Keynes showed how government institutions could use spending to ignite economic growth.

Schumpeter, a Keynes contemporary, focused on innovation -- in his words, "the setting up of a new production function" -- and what it brought to markets: entrepreneurs and dynamic change.

He knew that external events -- such as earthquakes and wars -- could lead to economic upheaval.

Money Moves

Capitalism possesses an internal mechanism of violent change, thanks to entrepreneurs' actions. These agents of innovation present creative ways of building a product or service to spur demand and create new markets.

Older businesses wither or die as younger, more aggressive firms move to the top. Some workers and even communities suffer at the expense of such disruptive change, a process Schumpeter called "creative destruction."

It's all worth it, he argued, because the overall standard of living rises. Over time, more people can buy high-quality goods at low prices.

"The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers' goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates," Schumpeter wrote in his 1942 best-seller, "Capitalism, Socialism and Democracy."

Peter Boettke, a professor of political economy at George Mason University in Virginia, likens capitalism's success to a horse race.

One horse, named Schumpeter, represents innovation. The second horse, called Smith, stands for free trade. The third is government "and its stupid decisions," Boettke said.

"As long as the first two horses stay ahead of the stupid horse, the economy's cycles are manageable," he told IBD. "The trouble happens when the stupid horse's nose gets in front by (creating) policies that restrict trade or are anti-technology."

Schumpeter was born in 1883 in a hamlet 75 miles south of what is now Prague.

When he was 4, his father died in a hunting accident. A year later he and his mother, Johanna, moved to Graz, Austria, where she married a general. Then they moved to Vienna so Jozsi could attend top schools.

He shone in school. At the famed Theresianum high school, he studied Latin and Greek. He also took classes in English, Italian, French and his native German. Thus armed, he and other grads trained to fill key posts across Austria-Hungary, Thomas McCraw wrote in "Prophet of Innovation: Joseph Schumpeter and Creative Destruction."

After graduation, Schumpeter studied economics at the University of Vienna. He explored English traditional economists and Austrian teachers who preached marginalism, or how people choose goods and production methods.

He also dined on the writings of Karl Marx, who stressed the changing nature of capitalism.

Vienna's coffeehouses gave scholars a chance to spar on a wide range of topics. Schumpeter met and debated with the likes of Max Weber, a pioneer in the field of sociology.

Schumpeter traveled to Germany and England and met top economists. Soon after returning to Austria-Hungary, he landed his first professorship at Czernowitz at age 26.

He gained stature by taking teaching jobs at more prestigious schools, including the University of Bonn in Germany and later at Harvard in Cambridge, Mass.

Schumpeter grabbed every opportunity to speak, be it as far away as Japan. He charmed audiences with lectures that crisscrossed from economics to sociology, history and other fields. To boost his academic star status, he also wined and dined with the social elite of Europe.

"He was a combination of George Clooney and Albert Einstein," McCraw, a Harvard business professor, said in a Harvard University Press podcast. "He's the most intelligent person I have ever studied."

When Schumpeter first visited America in 1913, he traveled by train from the East Coast to California and back. He saw the nation's highly productive factories, railroads and other centers of commerce.

Schumpeter wrote essays blasting holes through Marx's view that in a capitalist society the rich get richer and the poor stay poor.

Schumpeter pointed out that a study of the wealthiest families in mid-19th-century Europe showed that they were no longer at the top three generations later.

In his view, classes did not form because of capitalism. They formed because people spent more time with other people of the same background, interests and social standing. Schumpeter argued that if a man wanted to reach a higher class, becoming an entrepreneur gave him that chance, McCraw says.

Schumpeter saw that investors fuel capitalism because they finance new ideas. They provide credit, knowing all the while that they could lose 100% of their investment.

He also saw U.S. corporations -- from AT&T (NYSE:T - News) to General Electric (NYSE:GE - News) to DuPont (NYSE:DD - News) -- create labs for research and development to refresh profit growth.

Schumpeter knew capitalism's vicious cycles at a personal level.

Determined to help rebuild Austria after it ended on the losing side of World War I and its empire was torn apart, Schumpeter took a break from teaching and had a brief but frustrating stint as finance minister.

Next, he enjoyed success as an investment banker. But Austria's stock market crashed in 1924, wiped out Schumpeter's gains and put him in huge debt. He spent years writing articles, teaching and giving lectures to pay off creditors.

Down, Not Out

In 1926, the deaths of his beloved mother and his second wife, Annie, during childbirth caused Schumpeter deep grief. To get by each day, he put his mind entirely on his work. Like Benjamin Franklin, he graded the quality of his work daily from 0 to 1, rarely giving a perfect score.

In a letter to Austrian journalist and friend Gustav Stolper, Schumpeter wrote: "Everything now hangs on my ability to work. If so, the engine will keep running, even if my personal life is over."

Schumpeter's engine roared for decades until his death in 1950.

In addition to writing several more books and scores of articles, he taught at Harvard with gusto. In classes that he taught every year, he never gave the same lecture. Among his pupils: Nobel prize winners Paul Samuelson and James Tobin.

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