#9 Joseph Alois Schumpeter: The Creative (but Destructive) Genius

If Schumpeter should be summed up with one adjective, “creative” is the most suitable one. And this is why he ranks higher than Kirzner in my view. While Kirzner is by-and-large right about most things, his creativity is more incremental and his interests more limited.  Schumpeter, on the other hand, was wrong about a lot of things, although sometimes it is difficult to tell whether he was just plain wrong or if he drew erroneous conclusions for ironic purposes.

I think that what most characterizes creative people is their ability to combine apparently distant ideas, theories, or approaches. Schumpeter was a master of such creative combinations. If one looks at his two most famous works-The Theory of Economic Development and Capitalism, Socialism, and Democracy – it is clear that there are four recurring components that are combined in different proportions in Schumpeter’s thinking: dynamic Austrian economics; Walrasian equilibria; Nietzschean notions of ubermenschen; and Weberian sociology. To this stew, Schumpeter added his own brands of ironic pessimism.

Needless to say, I’m skeptical – to say the least – about some of these components. But all are actually needed to produce a coherent theory. Without entrepreneurial heroes, it is difficult to see how the “circular flow” can be rescued from the destruction of a continuous swarm of local entrepreneurs; it is also difficult to see how anything approaching equilibrium can ever be approximated in an industrialized economic system. Likewise, the supposed “efficiency” of bureaucratic, large-scale entrepreneurship depends on the existence of a superior class of innovating supermen who can be put in charge of corporate decision-making.

But even though I don’t believe in supermen or circular states (in a post-agricultural economy) or share the Weberian faith in bureaucracy, I still think that Schumpeter’s contributions represented real progress. He was the first one to give us a coherent theory of entrepreneurship, where entrepreneurs are (correctly) understood as the creative-destructive agents that cause economic development and introduce innovations into the economy. The theory is both evolutionary and based on the implicit recognition that individuals have to interpret economic data; they are not simply given as unambiguous and universally recognized bits of information. Indeed, it is Schumpeter’s focus on innovation and suboptimal equilibria – rather than arbitrage and optimal equilibria – that makes his theory more satisfying than Kirzner’s later attempt, in spite of also having more blatant shortcomings.

Another fascinating aspect of Schumpeter’s writings is that he reveals himself both as a conservative and as a pessimist. His most well-known conclusion is that socialism is inevitable. But unlike socialists with this belief, Schumpeter thought that the inevitability of socialism is as inspiring as the inevitability of death. The historian Jerry Z. Muller (The Mind and the Market , 2002, p. 294) points to Pareto’s influence on Schumpeter:

“In attempting to account for the appeal of socialism, Schumpeter … borrowed from … Pareto. Pareto’s 1901 essay … conveys two themes to which Schumpeter would return time and time again: the inevitability of elites, and the importance of nonrational and nonlogical drives in explaining social action. Pareto suggested that the victory of socialism was “most probable and almost inevitable.” Yet he predicted [that] the reality of elites would not change. It was almost impossible to convince socialists of the fallacy of their doctrine … since they were enthusiasts of a substitute religion. In such circumstances, arguments are invented to justify actions that were arrived at before the facts were examined, motivated by nonrational drives.”

Schumpeter considered the capitalist system superior to its alternatives, as Muller (2002, p. 306) also explains:

“Schumpeter was skeptical of …  antitrust … What those who criticized monopoly in the name of free competition failed to understand was that it was in the very nature of dynamic capitalism to produce high, “monopoly” profits for those who were the first to innovate successfully, [thus] large firms had to continue to innovate or face decline …. the interpretation of the Depression by intellectuals had led to a “radicalization” of the public mind in the United States, which in turn had resulted in policies that left capitalism in shackles.”

A very interesting assertion of Schumpeter’s was that even if the proponents of capitalism manage to succesfully defend capitalism against one of the charges raised against it – for example that decentralized planning is less efficient than central planning – it is inevitable that the critics will find some other argument that becomes as important as the refuted argument had been previously. According to Schumpeter, the fact remains that intellectuals and many others do not like capitalism on the basis of their unexamined and irrational subjective judgments.

Although I am not as pessimistic as Schumpeter, I think we can now agree that he was prescient about the difficulties faced by the defenders of free markets. There is now a general agreement that markets work better than Soviet-style central planning. But there is no shortage of people who (erroneously, in my view) believe that the current financial crisis was caused by free markets rather than government regulations and subsidies, and an even greater number of people who think that markets are bad for the environment (in spite of the positive correlation between air/water pollution and the absence of clearly defined private property rights).

#10 Israel Meir Kirzner: A Gateway to Economic Sanity

I start the countdown by selecting Israel Kirzner as my 10th favorite thinker. I do not think that he is right about everything, but it is hard to overestimate his ability to make the reader (i.e. me) think.

When I first read his most well-known book, Competition and Entrepreneurship, it was akin to a revelation. My vague dissatisfaction with mainstream theory seemed explained and solved: the source of the problem is that there is no entrepreneur in contemporary neoclassicism, because end-state equilibria assume that the entrepreneurial problem has already been solved.

This had the effect of making me a downright “Kirznerian” for a while (my paper “The Spatial Nature of Entrepreneurship” is almost as Kirznerian as Kirzner himself). But then I became increasingly skeptical, and in my later writings I have spent more time criticizing than defending Kirzner’s conception of  entrepreneurial “alertness,” “discovery” and so on. But this does not mean than I don’t like his theory. I think we should all be grateful to Kirzner for having articulated an extraordinarily consistent, thin, and elegant theory.

The reason I call Kirzner a gateway to economic sanity is that he is sufficiently grounded in the neoclassical tradition to be taken seriously by the more open-minded of mainstream economists, yet he explains some of its most serious flaws in a way that is more likely to keep such economists reading than more heterodox or less polite critics of the received view.  In other words, Kirzner’s work is a sort of “gateway drug” to the even more mind-altering substance of, say, “The Economics of Time and Ignorance” or “Knowledge, Institutions, and Evolution in Economics.”

Unfortunately, the neoclassical sponge has lately had a tendency to integrate the form of Kirzner’s theory while draining it of its substance. In the expansive field of “entrepreneurship studies,” Kirzner is often referred to but seldom understood. Contrary to superficial interpretations, Kirzner’s theory is not a theoretical foundation for empirical studies of small business formation, unless it’s understood that business formation is only a minor subset of profit-yielding human action.

An attractive aspect of Kirzner’s work is that he never emphasizes the policy implications of his theory, which are numerous. While these implications are largely pro-market of the classical liberal variety, policy advocacy never seems to be his main objective. He is first and foremost an economist, who will occasionally provide the reader with understated observations regarding the benefits of free markets, but it’s mostly left to the reader to draw their own conclusions. I think this style is much to be preferred over more passionate policy advocacy (I don’t mind passion, but I think someone who gets passionate about tax rates has got his priorities jumbled up; surely there are other things that should be more likely to excite the passions of homo sapiens).

Israel Kirzner has an interesting background. While he was born in London, he has lived in New York for many years. When listening to a recording of one of his lectures, I was struck by his unique brand of spoken English: an idiosyncratic mixture of British intonation and two types of American pronunciation (New York and standard American).

Another unusual aspect is that he is not only an economist; he is also an Orthodox rabbi and scholar. Indeed, one might even call his style of economic analysis “rabbinical.” And it is perhaps this other occupation that explains his relative lack of passion when he does discuss economic policy choices.

Top Ten Countdown of My Favorite Thinkers

I have decided to reveal my intellectual preferences by doing a countdown of my 10 favorite thinkers. Given my educational background, this will be a very subjective list and limited to economics and adjacent disciplines. I will also attempt to motivate my choices, and  give an indication of what I like and don’t like about each individual (obviously, the pros will have to outweigh the cons). I haven’t decided the exact ranking yet, but I have a general idea about who will be included. Watch this space.