there’s a guiding concept dominating the economy right now. Disruption, according to the general mantra, has recently become the key to understanding the enormous power of the digital revolution. To explaining the leaps in technological innovation of the past years. And to having any chance at all as an entrepreneur in the accelerated digital capitalism of the twenty-first century.
Accordingly, a good idea is all you need. It crumbles business models that have been successful for years, breaks up previously successful companies and destroys entire industries. What remains is the conquerors with their idea. Companies such as Airbnb, Netflix, Uber, Alibaba and Apple. They reap the rewards of their supremacy for a time. Then a new idea emerges, new conquerors enter the arena and everything starts all over again. That’s how disruption works.
It’s been raging everywhere for some time now. Bookshops have been caught up by it, newspapers, television broadcasters, travel agencies, taxi companies, hoteliers and soon possibly also the local bar and supermarket around the corner. Countless analyses and diagnoses deal with it. And yet, in the end, they all find a common analytical anchor in an Austrian who in old age is supposed to have boasted that as a young man his goals were to be the world’s greatest economist, the best horseman in all of Austria and the greatest lover in all of Vienna—and just the bit with the horses didn’t work out, unfortunately, because of a bad saddle.
FOREFATHER OF CHANGE
We are talking about Joseph Alois Schumpeter: born in 1883 in Triesch, Moravia, in what was then Austria-Hungary, political economist, politician and the inventor of terms such as innovation, venture capital and business strategy. To this day, he is considered the forefather of disruption. Every analysis about innovations, every lecture about technological progress, every presentation about technological moonshots is based on his work. And it is only now that the full impact of his ideas is really being felt.
It took time and there were many twists and turns before Schumpeter’s ideas made a big breakthrough in economics. The young economist caused his first uproar back in 1911. At the time he declared the entrepreneurial role to be the “intrinsic basic phenomenon of economic development.” Before that, the economics of business life were described as a static cycle of eternally unchanging pathways. In contrast, Schumpeter brought the terms dynamic and change into economics for the first time. He was the first to put into words the fact that the actual economy worked very differently than how previous theoreticians had described it. Instead of running in a cycle of never-changing pathways, the central dynamic of change is innovation, which ensures that improved and completely new products appear in shops, more advanced factories produce more quickly and at lower costs, and that a broader range of increasingly better products emerges. As Schumpeter saw it, established companies are constantly being challenged by new competitors and he recognized that the entrepreneurs themselves were the initiators of this change. They ensured that new methodologies were implemented and fought to see who would be the first to achieve a breakthrough with a new product.
It initially seemed as if Schumpeter’s ideas would achieve a rapid breakthrough. In 1911, the University of Graz appointed him as a professor, the youngest in the Austro-Hungarian Empire. Columbia University in New York awarded him an honorary doctorate. In an extraordinary synthesis of economic models, sociological observations and psychological analysis, Schumpeter recognized the central importance of the businessperson he described as an entrepreneur more than a century ago. While sheep were still being set out to pasture in what is today Silicon Valley, Schumpeter wrote how entrepreneurs undauntedly promoted innovations as “new combinations of things and forces” and passionately fought against the odds for such innovations to become established in the market.
“Positive heroes of change, endowed with unbridled energy and willpower.”
HEROES OF PROGRESS
Schumpeter also provided an explanation for this pioneering spirit. As he saw it, the driving force for these new entrepreneurs was not just the simple pursuit of profit. He saw such purely economic motivations at best in capitalists and arbitrageurs who only used differences in prices or interest to maximize their profits. He very deliberately separated these investors and speculators from his entrepreneurs. Instead, the motives of the entrepreneur weren’t primarily monetary, but rather of a psychological nature. They were firstly fueled by the “dream and will to found a private empire,” and secondly by viewing “economic activity as a sport.” Thirdly, the entrepreneur is driven by “the joy of creating and of doing.”
Schumpeter’s creative entrepreneurs thus clearly distinguish themselves from the type of exploitative and oppressive entrepreneurs described by Karl Marx. They act instead as positive heroes of change, endowed with unbridled energy and willpower, driven by the desire for independence and freedom. For them, the challenges of competition and the constant search for new opportunities are simply fun.
CHANGE AND GROWTH
At the same time, Schumpeter described the economic incentive of change. People who become successful with a “new combination of things and forces” and can set themselves apart from the competition with what today would be called product, process and/or organizational innovations would be rewarded with the high entrepreneurial profit of the quasi-monopolist. At least until imitators appear on the scene, copy the innovation and finally “compete down” the innovator. Schumpeter described this process, which could be found today in any encyclopedia entry about disruption, back in 1911. He didn’t describe it as “creative” or “inventive” destruction until 1942, when he recognized creative destruction as the central core of every market economy.
Although Schumpeter’s words may seem plausible, far-sighted and clear today, they found very little resonance in academic economics at the time. Schumpeter himself also ended up initially turning to other interests in his rapid rise in academia. In 1919, he was appointed as the independent finance minister of Austria for a short time. Later he directed a private bank and lived out his hedonistic side in the licentious urbanity of Viennese society.
It was the world economic crisis that drove Schumpeter back into academia. He was offered a professorship in Bonn in 1925, which enabled him to make a comeback. Seven years later, his move to Harvard led him to the Olympus of academia. In 1948, the members of the American Economic Association elected him president of the organization, the world’s most influential scholarly society in his field. However, his idea of creative destruction remained nothing but a shadowy presence in economics. Nothing changed, even after his death in 1950. Ironically, Schumpeter himself was responsible for the fact that the idea that would make him famous was hardly noticed during his lifetime. As an academic, he repeatedly demanded that economic relations be formulated in mathematical formulas to make them more precisely analyzable. Yet his own comparative advantage lay in inspired interdisciplinary analyses and not in formulization.
At any rate, economic research followed the path of formulization—and initially ignored Schumpeter’s verbally formulated insights into the beneficial work of entrepreneurs. Mathematical models dominated growth theory for many decades and at first completely ignored the entrepreneur personality as a decisive factor. The models were able to show how growth can be increased over the short term through higher savings and the resulting investments, but technical progress as the most important driver of long-term economic development remained without a convincing explanation.
CREATIVE DESTRUCTION 2.0
It was the French-Canadian economic duo of Philippe Aghion and Peter Howitt who brought Schumpeter back to the center of modern growth economics in 1992. Their trick was to translate Schumpeter’s central insights into the world of mathematical models and thus make it possible to connect them to the discipline’s mainstream. The basic model of Aghion and Howitt describes in a few equations how entrepreneurs continually compete with one another. In each round of competition they must decide whether they wish to rely on proven processes and thus generate secure sales or whether they want to take the risk of investing (more) in research and development. This R&D has a certain probability of producing an innovation, which would allow the entrepreneur to achieve significantly higher monopoly profits, at least for a certain period of time.
Since then, Philippe Aghion in particular, a professor at the London School of Economics and also at the head of the French academic system at the Collège de France in Paris, has repeatedly demonstrated the efficiency of the Schumpeter paradigm. Aghion’s research supplies fascinating answers to the question of optimal framework conditions for innovation: How long should innovations be protected by patents? Does a higher or lower competitive intensity lead to more technological progress? Should the state pursue active industrial policies and specifically promote individual sectors or even individual companies? Why must the education and research system be structured differently in leading technological countries than in those economies in which companies seek success primarily in inexpensive imitation?
The models inspired by Schumpeter can also provide important insights into current challenges that didn’t exist during Schumpeter’s lifetime. Aghion and others show how the direction of technological change could be steered with eco-taxes in such a way as to switch to an ecologically sustainable Green Economy. In this approach, known as directed technical change, the state sets the direction, for instance by introducing a tax on carbon-dioxide emissions, but doesn’t have to anticipate, let alone determine which technology will ultimately be successful.
The Age of Schumpeter
When it comes down to questions of progress and development, innovation and competition, patent protection and growth financing, Schumpeter’s perspective is hard to ignore these days. The findings of the so-called neo-Schumpeterian models are becoming increasingly important, particularly for highly developed industrial countries that are at the technological frontier.
Back in 1984, Herbert Giersch, the president of the Kiel Institute for the World Economy at the time, argued that now, after the end of the era of Keynesianism, an epoch marked by economic liberalization and advances in computer technology was on the horizon. Giersch speculated that this could perhaps be best understood and shaped with Schumpeter as an intellectual figurehead. Neither the fall of the Berlin Wall nor the collapse of the Soviet Union nor the dynamic of the subsequent globalization and digitization were foreseeable at the time. Giersch therefore hedged his prediction of what he termed the coming “Age of Schumpeter,” remarking that future history itself must be the judge. Today, in the year 2019, future history has spoken: the Age of Schumpeter has arrived and we’re right in the middle of it.
Dr. Nils aus dem moore
directs the “Sustainability and Governance” research group at the Halle Institute for Economic Research and is also the deputy head of its Berlin office.