©Deirdre Nansen McCloskey | COPYRIGHTED MATERIAL

Creative Destruction vs. the New Industrial State: Review of McCraw and Galbraith

Prophet of Innovation: Joseph Schumpeter and Creative Destruction, by Thomas K. McCraw, Cambridge: Harvard University Press, 719 pages, $35

The New Industrial State, by John K. Galbraith, Princeton: Princeton University Press, 518 pages, $24.95

by Deirdre N. McCloskey
Reason magazine, October 2007
Filed under articles [criticism in history and economic history] [reviews]

The "embedded" capitalism of Joseph Schumpeter and John Kenneth Galbraith

Most of us get our politics in our early 20s and then never change. Saul Bellow said of his youthful Trotskyism, "Like everyone else who invests in doctrines at a young age, I couldn't give them up." A young adult hates the bourgeoisie or loves capitalism or believes passionately in the welfare state. Her politics becomes a cherished identity, a faith. Here I stand. I can no other.

The vintage matters. Someone who invested in doctrines when world capitalism seemed to be working just fine — on the eve of World War I, say — had a good chance of keeping for life an optimistic opinion of markets and entrepreneurs. So it was with one of the best-known economists of the last century, Joseph Alois Schumpeter (1883-1950) of Vienna, Bonn, and Harvard.

But someone who invested in his human capital when things were dismal and chaotic — early in the Great Depression, say — was likely to take a less cheerful view. So it was with another of the century's best-known economists, Schumpeter's younger colleague John Kenneth Galbraith (1908-2006) of Ontario, Berkeley, Fortune magazine, and then, at the very end of Schumpeter's two decades there, Harvard.

Both tried political power early, Schumpeter as a pro-market minister of finance in Austria's brief socialist government after World War I and Galbraith as a New Dealish deputy director of the U.S. Office of Price Administration during World War II. Experience in government had opposite effects on the two. Schumpeter became permanently suspicious of state power. Galbraith became permanently delighted with it.

These two men of clever words, both master rhetoricians, laid out the case for and the case against unregulated markets. Half a century on, you can review their efforts in a new biography of Schumpeter and a new reissue of Galbraith's most famous book, The New Industrial State. Schumpeter's pro-capitalist and conservative case looks better, Galbraith's anti-market and regulatory case looks worse.

Regulated or not, as Schumpeter almost understood, capitalism hangs on words. In the end that's what both men missed, Schumpeter only narrowly. Case-making with sweet words is how business decisions are made. It's how regulatory agencies do their jobs. It's how you shop for furniture. It's how economic scientists persuade. It's how managers in a free society manage. Rhetoric rules.

As Thomas McCraw, a professor of business history at Harvard Business School, explains in Prophet of Innovation, a charming new life of the man in full, Joseph Schumpeter from first to last defended the entrepreneur with his own talk, talk, talk. A free economy, Schumpeter claimed from his earliest important book, The Theory of Economic Development (1911), runs on innovation, not routine. "Schumpeter turned Karl Marx on his head," McCraw writes. "Hateful gangs of parasitic capitalists become, in Schumpeter's hands, innovative and beneficent entrepreneurs."

Emotionally speaking, Schumpeter had always been attracted to the aristocratic side of the bourgeoisie. "The innovating entrepreneur," noted one of Schumpeter's colleagues at Harvard, "did have glamour" — which Schumpeter sought — "and was not dominated by middle-class values," which Schumpeter viewed as stuffy conventionality without heroism. The aristocratic bourgeois: There's your Schumpeterian entrepreneur.

In public Schumpeter liked "to play the part of an aristocrat," McCraw writes, "even though his origins were middle-class and his eminence self-made." At his first academic job in 1909 he fought a literal duel with swords against, of all people, the librarian, because he wouldn't make books available to his students. The librarian got an honorable scar out of it, and the two became the best of friends.

Schumpeter "liked to disrupt faculty meetings by turning up late, still clad in jodhpurs and helmet from his daily horseback ride." He would say in later years that his ambition was to become the world's greatest economist, the world's greatest lover, and the world's greatest horseman. "Things are not going so well," he would add, smiling, "with the horses."

Schumpeter's best-known book is his hastily written but glittering Capitalism, Socialism, and Democracy, which received scant notice when it first appeared in 1942. It contained his usual praise for the businessperson, but it also predicted that capitalism would not survive, and that democracy might not either. The book "admits, and rather cheerfully, that the patient is dying," the economist Paul Samuelson wrote in a 1970 Newsweek column, "but of a psychosomatic ailment. No cancer, but neurosis is [the capitalist's] complaint. Filled with self-hate, he has lost his will to live."

Most intellectuals in the 1930s and early '40s had the same neurosis, and the same pessimism. Schumpeter believed that capitalism was raising up its own grave diggers — not in the proletariat, as Marx had expected, but in the sons and daughters of the bourgeoisie itself. Lenin's father, after all, was a high-ranking education official, Lenin himself a lawyer. It wasn't the children of autoworkers who pulled up the paving stones on the Left Bank in 1968. The most radical anti-globalists today are socialist children of capitalist parents.

Schumpeter's cultural pessimism about capitalism has proven wrong. The American economy has continued to show startling entrepreneurial vigor, though both Schumpeter and Galbraith thought that committees would kill it. The capitalist idea has flourished worldwide.

By 1967, when Galbraith published The New Industrial State, his most considered book (he revised it three times down to 1985), he was already famous among general readers for The Affluent Society (1958). In that book he pointed out that we Americans have grown affluent in private goods, loaded down with refrigerators and finned automobiles. Splendid. But we have neglected the public goods of education and public parks and decent provision for the poor. In Sweden, he averred, they do things better.

Ten years later The New Industrial State offered additional Sweden boosting. It has now been reissued with an introduction by the author's son James, also a notable economist on the Democratic left. The elder Galbraith argued that the great scale of modern industry has created a "technocracy," which runs the world with committees. Anyone who has worked in a large corporation or a large university knows the feeling. Galbraith argued that advertising manipulates demand in order to fit with technical necessities. Anyone who has lusted for an iPhone knows that feeling too. A new model of your father's Oldsmobile was so very expensive to plan and took so very long to bring to market — ask Airbus today about all this — that the demand had to be guaranteed with elaborate provision years in advance for advertising and distribution.

So let us adopt democratic socialism, said Galbraith. Let us concede that the new industrial state is one of massive corporations facing massive unions, under the benevolent and skillful regulation of massive governments. "The small competitive firm cannot afford the outlays that [modern, big-time] innovation demands," he wrote. If modernity needs big corporate bureaucracies to do such big stuff, surely we need big governments to coordinate everything; the so-called free price system won't do. "If the market is uncontrolled," Galbraith wrote, "it will not know" when the new car will roll off the line or when a new drug will pass FDA approval.

Rereading Galbraith long after his heyday, you'll find that his zingers are still funny, his arch sneers at the conventional wisdom still amusing — until you realize that the zinging and the sneering are there to cover his tracks. "For a public official to be called an economic planner was less serious than to be charged with Communism or imaginative sexual proclivities," he wrote, "but it reflected adversely nonetheless." Or consider his summary of the conventional wisdom regarding work: "Leisure is something to be regarded with misgivings, especially in the lower income brackets." Zing, zing.

The problem is that the tracks Galbraith is covering over are light. His works, essentially updatings of the great economic sociologist Thorstein Veblen, never really faced intellectual opponents with evidence. Galbraith in 1967, like Veblen in 1915, merely ran ahead laughing. While Schumpeter always acknowledged the very best academic and political cases made by his socialist opponents, Galbraith confined himself to making merry of pamphlets from the National Association of Manufacturers.

McCraw's book on Schumpeter is an absorbing read, with short chapters, lots of personal detail and historical scene setting, and an important anti-Galbraithian economic theme. McCraw argues that Schumpeter's search for "exact economics" — the ruling passion of modern economics, though not a passion that Galbraith indulged — was inconsistent with Schumpeter's profound discovery about the marketplace, namely, that it depends on invention, innovation, and entrepreneurship, all things counter, original, spare, strange. In Schumpeter's famous phrase from Capitalism, Socialism, and Democracy, borrowed from the German economist and sociologist Werner Sombart, capitalism depends on "perennial gales of creative destruction."

Beyond the insights into Schumpeter the economist and precursor of "strategy" courses in business schools, McCraw has dug out illuminating gossip. Schumpeter's diaries, available in full, get us into the head of a work-obsessed man — work-obsessed, at any rate, after a terrible summer in Bonn in 1926 at age 43, when the beloved mother of this beloved only child died suddenly of a stroke and his adored second wife with her newborn son died in her only childbirth. He wrote to a fellow economist, "Everything now hangs on my ability to work. If so, the engine will keep running, even if my personal life is over."

Schumpeter's personal life was not quite over. In 1937 he married for a third time, to Elizabeth Boody, herself a brilliant scholar, who sustained this peculiar working machine until his death in 1950. The chapter detailing the FBI's Keystone Cops pursuit of Joe and Elizabeth during World War II is alone worth the price of the book. Elizabeth Boody Schumpeter had correctly predicted that Japan would be no military pushover. That sufficed in the heat of wartime paranoia to draw the attention of the federal police. The agent reporting to J. Edgar Hoover about a volume on the Japanese economy edited by Elizabeth (the agent styled her maiden name and first-marriage name "aliases") could, unhappily, find no information "which shows clearly any intention either to aid or to oppose the Japanese."

Hoover shot back that on the contrary, "this case presents fairly good possibilities for eventually reaching prosecution." After all, husband Joseph himself was suspect, as an Austrian native who had doubts that unconditional surrender was a wise policy to impose on Germany a second time, or that killing many hundreds of thousands of Axis civilians with bombs was worthy of British or American values. (It was Galbraith, by the way, who headed the inquiry after the war showing how ineffective the strategic bombing of Germany had been.) FBI agents swarmed over Cambridge, McCraw notes, and "inevitably, many of [the Schumpeters'] acquaintances began to view them in a different light, and they suffered some cold shoulders."

Galbraith thought of Schumpeter as "the most sophisticated conservative of this century." The two got along well, trading wittily expressed opinions about capitalism. Both men had good senses of humor, whatever their disagreements. Schumpeter always thought of himself as a conservative, and planned a book on the matter, though he once said to Galbraith that "I am pretty sure that no conservative would recognize himself in the picture." In fact he was a conservative libertarian, well before the word libertarian got much respect. That is, he was not radically libertarian, willing to turn the society upside down, abolishing the government into the margins in the style of Ludwig von Mises, his classmate in a little economics seminar with the great Eugen von Böhm-Bawerk at the University of Vienna in 1905.

"I am not in the habit of crowning our bourgeoisie with laurel wreaths," wrote Schumpeter in his 1918 essay "The Crisis of the Tax State." Notice the sneeringly aristocratic imagery, conventional by then in European rhetoric and prominent in all of Galbraith's writings. As Schumpeter remarked a quarter of a century later, "The public mind has by now so thoroughly grown out of humor with [capitalism and the bourgeois life] as to make condemnation of capitalism and all its works almost a requirement of the etiquette of discussion."

But Schumpeter was bowing in 1918 to anti-bourgeois etiquette in order to set up the opposite point, that in fact the bourgeoisie "can do exactly what is needed now" and should be given its head. The irony, McCraw points out, is characteristic of the man, and of his theory of political economy: Capitalism was wholly successful economically but doomed sociologically.

Galbraith, like many other economists of his generation, worried about private monopoly, though embracing public monopolies. Schumpeter never had such worries. Creative destruction, he argued, would take care of the trusts and pools and over-big corporations. In truth the list of companies that Galbraith held in awe as great forces in 1967 looks quaint now. U.S. Steel, AT&T, and General Motors belie his assertion "of great stability in [a great corporation's] position in the planning system." Eight years after the first publication of The New Industrial State, Bill Gates founded Microsoft. Let creative destruction rip.

McCraw himself italicizes a very unripping assertion of his own that "the two pillars that support all successful business systems [are] a modern concept of private property and a framework for the rule of law." That's nothing like Schumpeter's idea. Laws are necessary, of course, but so are road mending and brick making. Private property and a framework for the rule of law have existed in written form since ancient Mesopotamia, and in every substantial civilization from third-century B.C. China to 12th-century A.D. Timbuktu. Roman law, with its detailed concept of private property, was worshipped in Europe for two millennia. Yet those civilizations, Schumpeter emphasized, never reached the standard of economic production and progress the modern West has. Not even close.

What was missing was the thing Schumpeter emphasized and Galbraith attacked, a thing unique about Europe since the Netherlands in 1600 and England in 1715: a business-dominated civilization. "Capitalism does not merely mean that the housewife may influence production by her choice between peas and beans," Schumpeter wrote in his swan song, a 1950 essay grimly entitled "The March Into Socialism." Capitalism also "means a scheme of values, an attitude toward life, a civilization — the civilization of inequality and of the family fortune." The last touch, incidentally, is pure Schumpeter: "The civilization of inequality" makes the socialists' case by adopting their words, yet Schumpeter politely disagrees on how we should judge the outcome.

The American "scheme of values" in the 19th century, Schumpeter said, "drew nearly all the brains into business" — witness, say, Mark Twain's failed entrepreneurial projects — "and impressed the businessman's attitudes upon the soul of the nation." Schumpeter remembered wistfully the pre-1914 civilization of Europe itself as following "the beliefs and attitudes of the business class," "essentially rationalist and utilitarian. It was not favorable to cults of national glory, victory, and so on" (though favorable enough, Professor Schumpeter, to start and sustain the Great European Civil War of 1914-1989).

"Capitalism stands its trial before judges who have the death sentence in their pockets," wrote Schumpeter. "The only success a victorious defense can possibly produce is a change in the indictment." Thus the major indictment of capitalism by the socialists of the 1850s was for immiserating the working people. When this proved scientifically wrong, the socialists of the 1890s indicted it for imperialism. When that too proved wrong, at any rate by the lights of the best economic scientists who troubled to look into the matter (among them Joseph Schumpeter), the socialists of the 1950s indicted it for alienation. When this accusation seemed less fresh, the socialists of the 1990s indicted it for environmental decay. Schumpeter wrote that "such refutation," rationally proving the latest indictment wrong, "may tear the rational garb of attack [on capitalism and all its work] but can never reach the extra-rational driving power that always lurks behind it."

Schumpeter stressed the robustness of capitalism in the economy, the vigor with which new entrants dissolve the monopoly profits of the first mover, and the enormous dividend it leaves for the poor. Robust, yes, but in a certain important respect still fragile: "The emotional attachment to the social order," wrote this conservative in an almost Burkean way, was "the very thing capitalism is constitutionally unable to produce." No one loves a Rockefeller. Everyone loves a Virgin Queen.

But there's still something missing. What both Schumpeter and Galbraith got right, and most modern economists have gotten wrong, is what the sociologists call capitalism's "embeddedness" in a society.

The economy is nothing without the words supporting it, whether conventional wisdom or creative entrepreneurial projects. Schumpeter was mistaken about the future of self-doubt among the bourgeoisie. The bourgeoisie claimed back its self-confidence after Reagan and Thatcher, and, more to the point, after Hayek and Friedman — though there's still work to be done in praising bourgeois virtues. Galbraith was mistaken in expecting the reduction of entrepreneurship to committees and the permanence of companies like General Motors. Entrepreneurship, even within a great organization, still matters. And as for the arrogant corporations, "nor is favor to men of skill; but time and chance happeneth to them all."

What's finally missing in both Schumpeter and Galbraith's grim prognoses is a theory of language. Human beings swim in words. We're just realizing this, after a long, long enchantment with Marxist or Freudian or behaviorist claims that secret or not-so-secret material interests rule everything, that the makers of the U.S. Constitution were driven by their property values, or that slavery was abolished to strengthen manufacturing. One quarter of national income is earned from sweet talk — that is, the persuasion a manager or teacher or salesperson or foreman exercises on the job.

"About the end of the seventeenth century," Schumpeter wrote in his great 1939 tome Business Cycles, the English political world "dropped all systematic hostility to invention. So did public opinion and the scribes." That's exactly right. And it's what is wrong with the materialist conviction since Marx that ideas are froth on deeper currents. Ideas, words, rhetoric, "reason": the world is governed, another economist said, by little else.

McCraw argues that Schumpeter invented what business schools now call "strategy," "an attempt by firms to keep on their feet," as Schumpeter put it, "on ground that is slipping away under them." It's practical business stuff. And of what is the "attempt" constituted? Plans, words, sweet talk. An economics that doesn't acknowledge talk and its creativity may be in some pointless sense "exact," but it doesn't illuminate the world we have, the world admired by Schumpeter and zinged by Galbraith, of entrepreneurs — in the market, the corporation, the government, the laboratory, the street. Capitalism, like democracy, is talk, talk, talk all the way down.